acid-test ratio

Fin

an accounting ratio used to measure an organization’s liquidity. The most common expression of the ratio is:

(Current assets – Inventory) / Current liabilities = Acid-test ratio

If, for example, current assets total $7,700, inventory amounts to $1,200 and current liabilities total $4,500, then:

(7,700 – 1,200) / 4,500 = 1.44

A variation of this formula ignores inventories altogether, distinguishes assets as cash, receivables, and short-term investments, then divides the sum of the three by the total current liabilities, or:

Cash + Accounts receivable + Short-term investments/Current liabilities = Acid-test ratio

If, for example, cash totals $2,000, receivables total $3,000, short-term investments total $1,000, and liabilities total $4,800, then:

(2,000 + 3,000 + 1,000) / 4,800 = 1.25

In general, the ratio should be 1:1 or better. It means a company has a unit’s worth of easily convertible assets for each unit of its current liabilities.