Acid Test Ratio - Revision history

User at 12:28, 2 September 2023

2023-09-02T12:28:23Z

User at 19:40, 23 November 2022

2022-11-23T19:40:03Z

User at 19:28, 23 November 2022

2022-11-23T19:28:06Z

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User at 16:53, 17 September 2019

2019-09-17T16:53:41Z

User: The acid test ratio is similar to the current ratio except that Inventory, Supplies, and Prepaid Expenses are excluded.

2018-11-27T19:09:18Z

The acid test ratio is similar to the current ratio except that Inventory, Supplies, and Prepaid Expenses are excluded.

New page

The acid test ratio is similar to the current ratio except that Inventory, Supplies, and Prepaid Expenses are excluded. In other words, the acid test ratio compares the total of the cash, temporary marketable securities, and accounts receivable to the amount of current liabilities. The larger the acid test ratio, the more easily will the company be able to meet its current obligations.The acid test ratio is also known as the quick ratio. <ref>What is the Acid Test Ratio [http://www.accountingcoach.com/blog/quick-ratio-acid-test-ratio Accounting Coach]</ref>

'''Formula'''<ref>The Acid Test Ratio Formula [http://www.investinganswers.com/financial-dictionary/ratio-analysis/acid-test-ratio-1225 Investing Answers]</ref>

The acid-test ratio can be calculated as follows:

Acid-Test Ratio = (Cash + Marketable Securities + Accounts Receivable) / Current Liabilities

A common alternative formula is:

Acid-Test Ratio = (Current assets – Inventory) / Current Liabilities

'''Example'''<ref>Example of The Acid Test Ratio [http://www.myaccountingcourse.com/financial-ratios/quick-ratio My Accounting Course]</ref>

Let's assume Carole's Clothing Store is applying for a loan to remodel the storefront. The bank asks Carole for a detailed balance sheet, so it can compute the quick ratio. Carole's balance sheet included the following accounts:

Cash: $10,000
Accounts Receivable: $5,000
Inventory: $5,000
Stock Investments: $1,000
Prepaid taxes: $500
Current Liabilities: $15,000
The bank can compute Carole's quick ratio like this.

[[File: Quick-ratio-formula.jpg|Quick Ratio Formula]]<br />
source: [http://www.myaccountingcourse.com/financial-ratios/quick-ratio My Accounting Course]

As you can see Carole's quick ratio is 1.07. This means that Carole can pay off all of her current liabilities with quick assets and still have some quick assets left over.

Now let's assume the same scenario except Carole did not provide the bank with a detailed balance sheet. Instead Carole's balance sheet only included these accounts:

Inventory: $5,000
Prepaid taxes: $500
Total Current Assets: $21,500
Current Liabilities: $15,000
Since Carole's balance sheet doesn't include the breakdown of quick assets, the bank can compute her quick ratio like this:

[[File: Quick-ratio-example.jpg|Absorption Costing]]<br />
source: [http://www.myaccountingcourse.com/financial-ratios/quick-ratio My Accounting Course]

'''Why it Matters'''<ref>Why does the Acid Test Ratio Matter [http://www.investinganswers.com/financial-dictionary/ratio-analysis/acid-test-ratio-1225 Investing Answers]</ref>

It is vital that a company have enough cash on hand to meet accounts payable, interest expenses, and other bills when they become due. The higher the ratio, the more financially secure a company is in the short term. A common rule of thumb is that companies with a Acid-Test or quick ratio of greater than 1.0 are sufficiently able to meet their short-term liabilities.

In general, low or decreasing acid- test ratios generally suggest that a company is over-leveraged, struggling to maintain or grow sales, paying bills too quickly, or collecting receivables too slowly. On the other hand, a high or increasing acid-test ratio generally indicates that a company is experiencing solid top-line growth, quickly converting receivables into cash, and easily able to cover its financial obligations. Such companies often have faster inventory turnover and cash conversion cycles.

Like most other measures, acid-test ratio does have its potential drawbacks. To begin, analysts commonly point out that it provides no information about the level and timing of cash flows, which are what really determine a company's ability to pay liabilities when due. The acid-test ratio also assumes that accounts receivable are readily available for collection, which may not be the case for many companies. Finally, the formula assumes that a company would liquidate its current assets to pay current liabilities, which is not always realistic, considering some level of working capital is needed to maintain operations.

It is also important to understand that the timing of asset purchases, payment and collection policies, allowances for bad debt, and even capital-raising efforts can all impact the calculation and can result in different acid-test ratios for similar companies. Capital needs that vary from industry to industry can also have an effect on acid-test ratios. For these reasons, liquidity comparisons are generally most meaningful among companies within the same industry.

===References===
<references />

← Older revision		Revision as of 12:28, 2 September 2023
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	*[[Accounts Receivable Factoring (FACTORING)\|Accounts Receivable Factoring (FACTORING)]]		*[[Accounts Receivable Factoring (FACTORING)\|Accounts Receivable Factoring (FACTORING)]]
	*[[Accounts Receivable Financing\|Accounts Receivable Financing]]		*[[Accounts Receivable Financing\|Accounts Receivable Financing]]
−	*[[IT Strategy (Information Technology Strategy)\|IT Strategic Planning]]
−	*[[E-Strategy\|e-Business Strategic Planning]]
−	*[[IT Governance\|Governance of Information Technology (ICT)]]
−	*[[Enterprise Architecture\|What is Enterprise Architecture Planning]]
−	*[[IT Sourcing (Information Technology Sourcing)\|Information Technology Sourcing (IT Sourcing)]]
−	*[[IT Operations (Information Technology Operations)\|Information Technology Operations (IT Operations)]]
−	*[[Chief Information Officer (CIO)\|Chief Information Officer (CIO)]]
−	*[[Leadership\|Leadership]]

@@ Line 62: / Line 62: @@
 == See Also ==
-[[Accounting Equation!Accounting Equation]]
+*[[Accounting Equation]]
-[[Accountable Care Organization (ACO)|Accountable Care Organization (ACO)]]
+*[[Accountable Care Organization (ACO)]]
-[[Accounts Receivable Factoring (FACTORING)|Accounts Receivable Factoring (FACTORING)]]
+*[[Accounts Receivable Factoring (FACTORING)|Accounts Receivable Factoring (FACTORING)]]
-[[Accounts Receivable Financing|Accounts Receivable Financing]]
+*[[Accounts Receivable Financing|Accounts Receivable Financing]]
-[[IT Strategy (Information Technology Strategy)|IT Strategic Planning]]
+*[[IT Strategy (Information Technology Strategy)|IT Strategic Planning]]
-[[E-Strategy|e-Business Strategic Planning]]
+*[[E-Strategy|e-Business Strategic Planning]]
-[[IT Governance|Governance of Information Technology (ICT)]]
+*[[IT Governance|Governance of Information Technology (ICT)]]
-[[Enterprise Architecture|What is Enterprise Architecture Planning]]
+*[[Enterprise Architecture|What is Enterprise Architecture Planning]]
-[[IT Sourcing (Information Technology Sourcing)|Information Technology Sourcing (IT Sourcing)]]
+*[[IT Sourcing (Information Technology Sourcing)|Information Technology Sourcing (IT Sourcing)]]
-[[IT Operations (Information Technology Operations)|Information Technology Operations (IT Operations)]]
+*[[IT Operations (Information Technology Operations)|Information Technology Operations (IT Operations)]]
-[[Chief Information Officer (CIO)|Chief Information Officer (CIO)]]
+*[[Chief Information Officer (CIO)|Chief Information Officer (CIO)]]
-[[Leadership|Leadership]]
+*[[Leadership|Leadership]]

@@ Line 1: / Line 1: @@
-The acid test ratio is similar to the current ratio except that [[Inventory]], Supplies, and Prepaid Expenses are excluded. In other words, the acid test ratio compares the total of the cash, temporary marketable securities, and accounts receivable to the amount of current [[liabilities]]. The larger the acid test ratio, the more easily will the company be able to meet its current obligations.The acid test ratio is also known as the quick ratio. <ref>What is the Acid Test Ratio [http://www.accountingcoach.com/blog/quick-ratio-acid-test-ratio Accounting Coach]</ref>
+The acid test ratio is similar to the current ratio except that Inventory, Supplies, and Prepaid Expenses are excluded. In other words, the acid test ratio compares the total of the cash, temporary marketable securities, and accounts receivable to the number of current liabilities. The larger the acid test ratio, the more easily will the company be able to meet its current obligations. The '''acid test ratio''' is also known as the '''quick ratio'''. <ref>[http://www.accountingcoach.com/blog/quick-ratio-acid-test-ratio What is the Acid Test Ratio -Accounting Coach]</ref>
-'''Formula'''<ref>The Acid Test Ratio Formula [http://www.investinganswers.com/financial-dictionary/ratio-analysis/acid-test-ratio-1225 Investing Answers]</ref>
+'''Formula'''<ref>[http://www.investinganswers.com/financial-dictionary/ratio-analysis/acid-test-ratio-1225 The Acid Test Ratio Formula -Investing Answers]</ref>
 The acid-test ratio can be calculated as follows:
-Acid-Test Ratio = (Cash + Marketable Securities + Accounts Receivable) / [[Current Liabilities]]
+Acid-Test Ratio = (Cash + Marketable Securities + Accounts Receivable) / Current Liabilities
 A common alternative formula is:
@@ Line 13: / Line 13: @@
-'''Example'''<ref>Example of The Acid Test Ratio [http://www.myaccountingcourse.com/financial-ratios/quick-ratio My Accounting Course]</ref>
+'''Example'''<ref>[http://www.myaccountingcourse.com/financial-ratios/quick-ratio Example of The Acid Test Ratio -My Accounting Course]</ref>
 Let's assume Carole's Clothing Store is applying for a loan to remodel the storefront. The bank asks Carole for a detailed balance sheet, so it can compute the quick ratio. Carole's balance sheet included the following accounts:
@@ Line 20: / Line 20: @@
 Accounts Receivable: $5,000
 Inventory: $5,000
-[[Stock]] Investments: $1,000
+Stock Investments: $1,000
 Prepaid taxes: $500
 Current Liabilities: $15,000
@@ Line 32: / Line 32: @@
 As you can see Carole's quick ratio is 1.07. This means that Carole can pay off all of her current liabilities with quick assets and still have some quick assets left over.
-Now let's assume the same scenario except Carole did not provide the bank with a detailed balance sheet. Instead Carole's balance sheet only included these accounts:
+Now let's assume the same scenario except Carole did not provide the bank with a detailed balance sheet. Instead, Carole's balance sheet only included these accounts:
 Inventory: $5,000
@@ Line 45: / Line 45: @@
-'''Why it Matters'''<ref>Why does the Acid Test Ratio Matter [http://www.investinganswers.com/financial-dictionary/ratio-analysis/acid-test-ratio-1225 Investing Answers]</ref>
+'''Why it Matters'''<ref>[http://www.investinganswers.com/financial-dictionary/ratio-analysis/acid-test-ratio-1225 Why does the Acid Test Ratio Matter -Investing Answers]</ref>
-It is vital that a company have enough cash on hand to meet accounts payable, interest expenses, and other bills when they become due. The higher the ratio, the more financially secure a company is in the short term. A common rule of thumb is that companies with a Acid-Test or quick ratio of greater than 1.0 are sufficiently able to meet their short-term liabilities.
+It is vital that a company have enough cash on hand to meet accounts payable, interest expenses, and other bills when they become due. The higher the ratio, the more financially secure a company is in the short term. A common rule of thumb is that companies with an Acid-Test or quick ratio of greater than 1.0 are sufficiently able to meet their short-term liabilities.
-In general, low or decreasing acid- test ratios generally suggest that a company is over-leveraged, struggling to maintain or grow sales, paying bills too quickly, or collecting [[receivables]] too slowly. On the other hand, a high or increasing acid-test ratio generally indicates that a company is experiencing solid top-line growth, quickly converting receivables into cash, and easily able to cover its financial obligations. Such companies often have faster inventory turnover and cash conversion cycles.
+In general, low or decreasing acid-test ratios generally suggest that a company is over-leveraged, struggling to maintain or grow sales, paying bills too quickly, or collecting [[receivables]] too slowly. On the other hand, a high or increasing acid-test ratio generally indicates that a company is experiencing solid top-line growth, quickly converting receivables into cash, and is easily able to cover its financial obligations. Such companies often have faster inventory turnover and cash conversion cycles.
-Like most other measures, acid-test ratio does have its potential drawbacks. To begin, analysts commonly point out that it provides no information about the level and timing of cash flows, which are what really determine a company's ability to pay liabilities when due. The acid-test ratio also assumes that accounts receivable are readily available for collection, which may not be the case for many companies. Finally, the formula assumes that a company would liquidate its current assets to pay current liabilities, which is not always realistic, considering some level of working [[capital]] is needed to maintain operations.
+Like most other measures, the acid-test ratio does have its potential drawbacks. To begin, analysts commonly point out that it provides no information about the level and timing of cash flows, which are what really determine a company's ability to pay liabilities when due. The acid-test ratio also assumes that accounts receivable are readily available for collection, which may not be the case for many companies. Finally, the formula assumes that a company would liquidate its current assets to pay current liabilities, which is not always realistic, considering some level of working capital is needed to maintain operations.
-It is also important to understand that the timing of [[asset]] purchases, payment and collection policies, allowances for bad debt, and even capital-raising efforts can all [[impact]] the calculation and can result in different acid-test ratios for similar companies. Capital needs that vary from [[industry]] to industry can also have an effect on acid-test  ratios. For these reasons, liquidity comparisons are generally most meaningful among companies within the same industry.
+It is also important to understand that the timing of asset purchases, payment and collection policies, allowances for bad debt, and even capital-raising efforts can all impact the calculation and can result in different acid-test ratios for similar companies. Capital needs that vary from industry to industry can also have an effect on acid-test ratios. For these reasons, liquidity comparisons are generally most meaningful among companies within the same industry.

← Older revision		Revision as of 16:53, 17 September 2019
Line 59:		Line 59:
	===References===		===References===
	<references />		<references />
		+
		+
		+	== See Also ==
		+	[[Accounting Equation!Accounting Equation]]
		+	[[Accountable Care Organization (ACO)\|Accountable Care Organization (ACO)]]
		+	[[Accounts Receivable Factoring (FACTORING)\|Accounts Receivable Factoring (FACTORING)]]
		+	[[Accounts Receivable Financing\|Accounts Receivable Financing]]
		+	[[IT Strategy (Information Technology Strategy)\|IT Strategic Planning]]
		+	[[E-Strategy\|e-Business Strategic Planning]]
		+	[[IT Governance\|Governance of Information Technology (ICT)]]
		+	[[Enterprise Architecture\|What is Enterprise Architecture Planning]]
		+	[[IT Sourcing (Information Technology Sourcing)\|Information Technology Sourcing (IT Sourcing)]]
		+	[[IT Operations (Information Technology Operations)\|Information Technology Operations (IT Operations)]]
		+	[[Chief Information Officer (CIO)\|Chief Information Officer (CIO)]]
		+	[[Leadership\|Leadership]]