Browse Accounting Lessons Here Accounting Terms & Definitions Accounting for Merchandising Activities Debits and Credits (Double Entry Accounting) Business Valuation Formulas Time Value of Money & Present/Future Values Complex Debt & Equity Instruments Common Stock & Shareholder's Equity Accounting & Finance Ratios Valuing Common Stock Corporate Income Taxes Lower of Cost or Market (LCM) & Inventory Valuation Chart of Accounts & Bookkeeping Bonds Payable & Long Term Liabilities Capital Assets GAAP, Accrual & Cash Accounting, Information Commodity, Internal Controls & Materiality What category of browser are you on this website? Accounting student (homework help) Finance professor (university research) Accounting manager (at work) Other Explore Careers in Accounting and Finance Visit our section on Careers in Accounting & Finance to explore vast opportunities in this industry.

Acid Test (Quick) Accounting Ratio - Calculation & Example of Current Assets divided by Current Liabilities

The acid-test or quick ratio is a variation of the current ratio that divides current assets by current liabilities to arrive at an answer. However, it is a stricter test of a company’s liquidity because it factors in to account only the most liquid assets that a company has including Cash, short term investments & accounts receivable.

How is it calculated?

 Acid-Test Ratio = (Cash + Short Term Investments + Accounts Receivable) / Current Liabilities

Inventory is not included in the acid-test ratio calculation because of the length of time needed to convert inventory to cash by making sales. However, there may be some types of inventories such as groceries, milk, eggs & meat that are more liquid than accounts receivable, however according to accounting standards; they may not be included in the acid-test ratio. Also, prepaid expenses are not included in the acid-test ratio because they cannot be converted in to cash and are not capable of covering current liabilities.

Example of Acid Test Ratio

 2004 2005 Assets Current Assets - Cash and Short Term investments \$45,000.00 \$52,500.00 - Accounts Receivable \$42,000.00 \$38,000.00 Total quick assets \$87,000.00 \$90,500.00 Total current liabilities \$66,200.00 \$64,300.00 Acid Test ratio i) \$87,000 / \$66,200 1.314199396 (1.31) ii) \$90,500 / \$64,300 1.407465008 (1.41)

Consider the following data for an imaginary company. We see that the company’s liquidity has increased from \$1.31 in 2004 to \$1.41 in 2005. This means the company has more liquid cash in 2005 than in 2004 which is certainly a good improvement. In 2005, the figure \$1.41 means the company has \$1.41 in liquid assets for every \$1 it has in current liability. Usually analysts prefer to have a ratio of 2:1 meaning for every \$1 of short term liability, the company has \$2 in cash to be able to repay its liability obligations.

The quick acid-test ratio is used by short term creditors to determine the deterioration or improvements in a company’s liquidity which indicates the company’s ability to meet its short term debt obligations and to be able to repay its debt maturing in the short term. Also, a lower quick ratio means the company will have greater difficulty in borrowing short term cash because banks know the company is cash strapped and has a high chance of not being able to repay its debts.