Definition of Acid Test Ratio
The acid test ratio, which is also known as the quick ratio, compares the total of a company’s cash, temporary marketable securities, and accounts receivable to the total amount of the company’s current liabilities.
The acid test ratio is considered to be a more conservative 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
Assume a company has cash of $7,000 + temporary marketable securities of $20,000 + accounts receivables of $93,000. This adds up to $120,000 of quick assets. If the company’s current liabilities amount to $100,000 the acid test ratio is 1.2:1.
A large acid test ratio gives creditors confidence that the company will be able to pay its current obligations when they come due.
