The acid test ratio or current ratio is an accounting ratio that indicates how the liquidity of a company is in the short term.When this ratio is calculated, it is because we are asking ourselves, can the company assume the payment of its short-term debts? The English name current ratio or quick ratio is also used.
Acid Test Formula
It is very easy, simple and fast to calculate and tells us a lot about the management and situation of a company’s treasury. Normally when a company shows weakness in this ratio, the market does not take long to penalize it.
It is therefore a good ratio to know the short-term payment capacity, indicating the solidity of the liquidity or solvency using the current assets (deducted the inventories for their little capacity to become money in the short term) divided by the current liabilities.
cid-Test Ratio , an indicator that determines whether a firm has enough short-term assets to cover its most urgent obligations without selling inventory. The quick ratio is much more stringent than the working capital ratio, primarily because the working capital ratio takes stocks into account.
The formula for calculating the quick ratio is as follows:
where Cash – cash;
Accounts Receivable – accounts receivable;
Short-Term Investments – short-term investments;
Current Liabilities – current liabilities.
Companies where the value of the quick ratio is less than 1 cannot fully pay for their short-term obligations. In addition, if the value of the quick ratio is much lower than the ratio of working capital, this means that working capital is very dependent on stocks. Retail stores are examples of this type of business.
The term “acid test” comes from the way in which miners tested gold nuggets. Unlike other metals, gold does not dissolve in acid. If the nugget did not dissolve in acid, then it was believed that it passed the acid test. Similarly, if a company’s financial report passes an acid test, this indicates its good financial condition.