Acid test ratio

Acid Test Ratio

A stringent liquidity measure that assesses a company’s ability to pay short-term obligations using only its most liquid assets, calculated by dividing quick assets (cash, marketable securities, and accounts receivable) by current liabilities.

For example, a retailer with $200,000 in cash, $150,000 in accounts receivable, $450,000 in inventory, and $500,000 in current liabilities would have an acid test ratio of 0.7 [($200,000 + $150,000) ÷ $500,000], indicating it might struggle to meet immediate obligations without selling inventory.

Also known as the quick ratio, this metric provides a more conservative view of liquidity than the current ratio by excluding inventory and prepaid expenses, which may take longer to convert to cash. A ratio of 1.0 or higher generally indicates good short-term liquidity, though optimal levels vary by industry. Companies with ratios below 1.0 may face challenges meeting obligations if revenue streams are disrupted, particularly in industries with slower inventory turnover.