The difference between the current ratio and the acid test ratio (or quick ratio) mainly involves the current assets inventory and prepaid expenses.
Definition of Current Ratio
The current ratio uses all of the current assets and divides their total by the total amount of current liabilities.
Definition of Acid Test Ratio
The acid test ratio uses only the following current assets (which are considered to be the "quick assets") and divides their total by the total amount of current liabilities:
- Cash and cash equivalents
- Short-term marketable securities
- Accounts receivable (net of the allowance for uncollectible accounts)
Notice that inventory (which is a significant current asset for retailers and manufacturers) and prepaid expenses are not included in the list of quick assets and therefore are not included in the acid test ratio.
Example of Current Ratio and Acid Test Ratio
To illustrate the difference between the current ratio and the acid test ratio, let's assume that a company has the following:
- Current liabilities $50,000
- 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 or 2:1 (total current assets of $100,000 divided by the total current liabilities of $50,000).
The acid test ratio is 0.8 or 0.8:1 (quick assets of $40,000 ($5,000 + $10,000 + $25,000) divided by the total current liabilities of $50,000.
