Acid Test (Quick Ratio)
Acid Test (Quick Ratio) = (Cash + Accounts Receivable + Short-term Investments) ÷ Current Liabilities
A stringent test that indicates if a firm has enough short-term assets (without selling inventory) to cover its immediate liabilities. It is similar but a more strenuous version of the "working capital" ratio, indicating whether liabilities could be paid without selling inventory.
Things to remember
- This is an extreme version of the working capital ratio because it only uses cash and equivalents.
- The ratio excludes inventory, which for some companies can make up a large portion of its assets.
For Cory's Tequila Co.: ($827 + $1189 + $1242) ÷ $3,003 = 1.08
Acid Test Analysis:
This ratio is used to determine risk that is not detected by the working capital ratio. Cory's Tequila Co. seems to be all right in this area. Their ratio of 1.08 means that they have just enough liquid assets to cover a unexpected drawdown of liabilities (people wanting their money immediately). Companies with ratios of less than 1 cannot pay their current liabilities and should be looked at with extreme caution. Furthermore if the acid ratio is much lower than the working capital ratio it means that current assets are highly dependent on inventory - retail stores are examples of this type of business.