What Is the Acid-Test Ratio?

The acid-test ratio, commonly known as the quick ratio, uses data from a firm's balance sheet to indicate whether it has the means to cover its short-term liabilities. Generally, a ratio of 1.0 or more indicates a company can pay its short-term obligations, while a ratio of less than 1.0 indicates it might struggle to pay them.

Understanding the Acid-Test Ratio

In certain situations, analysts prefer to use the acid-test ratio rather than the current ratio (also known as the 澳洲幸运5官方开奖结果体彩网:working capital ratio) because the acid-test method ignores assets such as inventory, which may be difficult to liquidate quickly. The acid-test ratio is thus a more conservative me𝓰tric.

Companies with an acid-test ratio of less than 1.0 do not have enough 澳洲幸运5官方开奖结果体彩网:liquid assets to pay their current liabilities and shou🏅ld be treated cautiously. If the 𒆙acid-test ratio is much lower than the current ratio, a company's current assets are highly dependent on inventory.

However, this is not a bad sign in all cases, as some business models are inherently dependent on inventory. Retail stores, for example, may have very low acid-test ratios without necessarily being in danger. The acceptable range for an acid-test ratio will vary among different industries, and you'll find that comparisons are most meaningful when analyzing peer companies in the same industry as each other.

For most industries, the acid-test ratio should exceed 1.0. On the other hand, a high ratio is not always good. It could indicate that cash has 🎀accumulated and is idle rather than being reinvested, returned to shareholders, or otherwise put to productive ▨use.

Calculating the Acid-Test Ratio

The numerator of the acid-test ratio can be defined in various ways, but the primary consideration should be gaining a realistic view of the company's liquid assets. Cash and cash equivalents shou🐎ld definitely be included, as should short-term investments, such as marketable securities.

澳洲幸运5官方开奖结果体彩网:Accounts receivable are generally included, but this is not appropriate for every industry. In the construction industry, for example, accounts receivable may take much more time to recover than is standard practice in other industries, so including 🎃it could make a firm's financial position seem much more secure than it is in reality.

The formula is:

$\begin{aligned} &\text{Acid Test} = \frac{ \text{Cash} + \text{Marketable Securities} + \text{A/R} }{ \text{Current Liabilities} } \\ &\textbf{where:} \\ &\text{A/R} = \text{Accounts receivable} \\ \end{aligned}$​Acid Test=Current LiabilitiesCash+Marketable Securities+A/R​where:A/R=Accounts receivable​

Another way to calculate the numerator is to take all current assets ✅and subtract illiquid assets. Most importantly, inventory should be subtr𒆙acted, keeping in mind that this will negatively skew the picture for retail businesses because of the amount of inventory they carry.

Other elements that appear as assets on a balance sheet should be subtracted if they cannot be used to cover liabilities in the short term, such as advances to suppliers, 澳洲幸运5官方开奖结果体彩网:prepayments, and deferred tax assets.

The ratio's denominator should include all current liabilities♉, debts, and obligations due within one year. It is important to note that time is not factored into the acid-test ratio. If a company's accounts payable are nearly due but its receiv🍰ables won't come in for months, it could be on much shakier ground than its ratio would indicate. The opposite can also be true.

Example of the Acid-Test Ratio

A company's acid-test ratio can be calculated using its balance sheet. Below is an abbreviated version of Apple Inc.'s (AAPL) balance sheet as of January 27, 2022, showing the components of the company's current assets and current liabilities (all figures in millions of dollars):

To obtain the company's liquid current assets, add:

• Cash and cash equivalents
• Short-term marketable securities
• Accounts receivable
• Vendor non-trade receivables

To get current liabilities, add:

• Accounts payable
• Other current liabilities

Then divide current liquid assets by current liabilities to calculate the acid-te𒀰st ratio. The calculation wouᩚᩚᩚᩚᩚᩚ⁤⁤⁤⁤ᩚ⁤⁤⁤⁤ᩚ⁤⁤⁤⁤ᩚ𒀱ᩚᩚᩚld look like this:

Apple's ATR = ($37,119 + $26,795 + $30,213 + $35,040) / ($74,632 + $49,167) = 1.05

Not everyone calculates this ratio the same. There is no single, hard-and-fast method for determining a company's acid-test ratio. Some analysts might include other balance sheet line items not included in this example, and others might remove the ones used here. So, it is important to understand how data providers arrive at their conclusions before using the metrics given to you.

The Bottom Line

The acid-test ratio, also called the quick ratio, is a metric used to see if a company is positioned to sell aꦍssets within 90 days to meet immediate expenses. In general𝓰, analysts believe that if the ratio is more than 1.0, a business can pay its immediate expenses. If it is less than 1.0, it cannot.

The reliability of this ratio depends on the industry the business you're evaluating operates in, so like many other financial ratios, it's best to use it when comparing similar companies.

Correction—Nov. 8, 2023: A previous version of this article stated that, in order to calculate current liabilities, you have to add accounts payable and other current assets, when it's actually other current liabilities.