The difference between the current ratio and the acid test ratio (or quick ratio) generally involves the current assets inventory, prepaid expenses, and some deferred income taxes.
The current ratio uses the total amount of all of the current assets.
The acid test ratio uses only the following current assets, which are considered to be quick assets: cash and cash equivalents, short-term marketable securities, and accounts receivable (net of the allowance for uncollectible accounts). In other words, the acid test ratio excludes inventory (which is a significant current asset for retailers and manufacturers) and some other amounts such as prepaid expenses and deferred income taxes (that are classified as current assets).
To illustrate the difference between the current ratio and the acid test ratio, let's assume that a company has current liabilities of $50,000 and has the following current assets:
- Cash and cash equivalents $5,000
- Short-term marketable securities $10,000
- Accounts receivable, net $25,000
- Inventory $56,000
- Prepaid expenses $4,000
The current ratio is 2 to 1 (or 2:1) calculated as: total current assets of $100,000 divided by the total current liabilities of $50,000.
The acid test ratio or quick ratio is 0.8 to 1 (or 0.8:1) calculated as: quick assets of $40,000 ($5,000 + $10,000 + $25,000) divided by the total current liabilities of $50,000.
