Definition of Acid Test Ratio
The acid test ratio, which is also known as the quick ratio, comparesthe total of a company’s cash, temporary marketable securities, and accounts receivable to the totalamount of the company’s current liabilities.
The acid test ratio is considered to be a better indicator of a company’s ability to meet its current obligations than the current ratio because inventories and prepaid expenses are not included.
Example of Acid Test Ratio
Let’s illustrate the acid test ratio by assuming thata companyhas cash of $7,000 + temporary marketable securities of $20,000 + accounts receivables of $93,000. This addsup to$120,000 of quick assets. If the company’s current liabilities amount to $100,000 theacid test ratio is 1.2:1.
A large acid test ratio gives creditors confidence that the company will be able to meet its current obligations when they come due.
