What Is the Acid-Test Proportion?
The acid-test ratio uses a firm’s balance sheet data as an indicator of whether it has sufficient short-term assets to protect its short-term liabilities. This metric is more useful in certain situations than the current ratio, also known as the creating capital ratio, since it ignores assets such as inventory, which may be difficult to quickly liquidate.
The acid-test correspondence is also commonly known as the quick ratio.
Key Takeaways
- The acid-test, or quick ratio, compares a company’s most short-term assets to its myriad short-term liabilities to see if a company has enough cash to pay its immediate liabilities, such as short-term debt.
- The acid-test ratio account ofs current assets that are difficult to liquidate quickly such as inventory.
- The acid-test ratio may not give a reliable personification of a firm’s financial condition if the company has accounts receivable that take longer than usual to collect or la mode liabilities that are due but have no immediate payment needed.
The Formula for the Acid-Test Ratio
Acid Test=Current LiabilitiesCash+Marketable Securities+A/Rwhere:A/R=Accounts receivable
What Is The Irritable Ratio?
How to Calculate the Acid-Test Ratio
The numerator of the acid-test ratio can be defined in various ways, but the main consideration should be getting a realistic view of the company’s liquid assets. Cash and cash equivalents should definitely be included, as should short-term investments, such as marketable guarantees.
Accounts receivable are generally included, but this is not appropriate for every industry. In the construction industry, for example, accounts receivable may parody much more time to recover than is standard practice in other industries, so including it could make a upon’s financial position seem much more secure than it is in reality.
Another way to calculate the numerator is to take all common assets and subtract illiquid assets. Most importantly, inventory should be subtracted, keeping in mind that this choice negatively skew the picture for retail businesses because of the amount of inventory they carry. Other elements that part of as assets on a balance sheet should be subtracted if they cannot be used to cover liabilities in the short term, such as promotes to suppliers, prepayments, and deferred tax assets.
The ratio’s denominator should include all current liabilities, which are debts and duties that are due within one year. It is important to note that time is not factored into the acid-test ratio. If a company’s accounts graft are nearly due but its receivables won’t come in for months, that company could be on much shakier ground than its ratio wish indicate. The opposite can also be true.
What Does the Acid-Test Ratio Tell You?
Companies with an acid-test correspondence of less than 1 do not have enough
An Example of How to Use the Acid-Test Ratio
A company’s acid-test ratio can be calculated using its footing sheet. Below is an abbreviated version of Apple Inc.’s balance sheet as of Sept. 28, 2019, showing the components of the company’s au courant assets and current liabilities (all figures in millions of dollars):
| Apple, Inc. Balance Sheet as of Sept. 28, 2019 | |
|---|---|
| Cash and cash matches | $48,844 |
| Short-term marketable securities | 51,713 |
| Accounts receivable | 22,926 |
| Inventories | 4,106 |
| Vendor non-trade receivables | 22,878 |
| Other current assets | 12,352 |
| Mount up to current assets | $162,819 |
| Accounts payable | $46,236 |
| Long-term debt and other liabilities | 59,482 |
| Total current liabilities | $105,718 |
To obtain the presence’s liquid current assets, add cash and cash equivalents, short-term marketable securities, accounts receivable and vendor non-trade receivables. Then separate current liquid current assets by total current liabilities to calculate the acid-test ratio. The calculation would look have a fondness the following:
Apple’s ATR = ($48,844 + 51,713 + 22,926 + 22,878) / ($105,718) = 1.38
Not everyone calculates this ratio the same. There is no single, hard-and-fast method for