# Acid Test Ratio

### Accounts Receivable Dictionary ## What is the Acid Test Ratio?

The acid test ratio, also known as the quick ratio, is a financial metric that measures a business's ability to meet its short-term obligations. It is calculated by dividing the sum of the business's current assets and its short-term investments by its current liabilities.

To calculate the acid test ratio, a business first needs to determine the total value of its current assets. This includes cash, accounts receivable, and short-term investments. Next, the business needs to determine the total value of its short-term investments. These are investments that can be easily converted into cash within one year.

Once the values of the current assets and short-term investments have been determined, the business needs to add these values together to get the total value of its liquid assets. This is the numerator of the acid test ratio formula.

To get the denominator of the formula, the business needs to determine the total value of its current liabilities. This includes accounts payable, short-term loans, and other obligations that must be paid within one year.

Once the values of the liquid assets and current liabilities have been determined, the acid test ratio can be calculated by dividing the total value of the liquid assets by the total value of the current liabilities. The result is expressed as a decimal or percentage.

A high acid test ratio is generally considered to be a sign of financial health, while a low ratio may indicate that the business is at risk of not being able to meet its short-term obligations.

## How is acid-test ratio calculated?

The acid test ratio is calculated by dividing the sum of a business's current assets and its short-term investments by its current liabilities.

To calculate the acid test ratio, a business first needs to determine the total value of its current assets. This includes cash, accounts receivable, and short-term investments. Next, the business needs to determine the total value of its short-term investments. These are investments that can be easily converted into cash within one year.

Once the values of the current assets and short-term investments have been determined, the business needs to add these values together to get the total value of its liquid assets. This is the numerator of the acid test ratio formula.

To get the denominator of the formula, the business needs to determine the total value of its current liabilities. This includes accounts payable, short-term loans, and other obligations that must be paid within one year

Once the values of the liquid assets and current liabilities have been determined, the acid test ratio can be calculated by dividing the total value of the liquid assets by the total value of the current liabilities. The result is expressed as a decimal or percentage.

For example, if a business has \$100,000 in liquid assets and \$50,000 in current liabilities, its acid test ratio would be calculated as follows:

Acid Test Ratio = \$100,000 / \$50,000= 2.00

This means that the business has enough liquid assets to cover its current liabilities two times over.

## What is acid-test ratio example?

A business has \$100,000 in cash, \$50,000 in accounts receivable, and \$25,000 in short-term investments. It has \$75,000 in accounts payable and \$25,000 in short-term loans.

To calculate the acid test ratio, the business first needs to determine the total value of its current assets.

This is calculated as follows:

Total Current Assets = \$100,000 + \$50,000 + \$25,000= \$175,000

Next, the business needs to determine the total value of its current liabilities.

This is calculated as follows:

Total Current Liabilities = \$75,000 + \$25,000= \$100,000

Once the values of the current assets and current liabilities have been determined, the acid test ratio can be calculated as follows:

Acid Test Ratio = \$175,000 / \$100,000= 1.75

This means that the business has enough liquid assets to cover its current liabilities 1.75 times over.

## Is a higher acid-test ratio better?

Yes, a higher acid test ratio is generally considered better. The acid test ratio is a measure of a business's ability to meet its short-term obligations, and a higher ratio indicates that the business has a stronger ability to do so.

A high acid test ratio indicates that the business has a significant amount of liquid assets, such as cash and short-term investments, relative to its current liabilities.

This means that the business has a strong ability to pay its short-term obligations and is less likely to face financial difficulties.

On the other hand, a low acid test ratio may indicate that the business does not have enough liquid assets to cover its current liabilities. This can put the business at risk of not being able to meet its obligations and could lead to financial difficulties.

Overall, a higher acid test ratio is generally considered better, as it indicates that the business has a stronger ability to meet its short-term obligations. A low ratio may indicate that the business is at risk of not being able to pay its obligations and could face financial difficulties.

## What is a considered a good, or bad acid-test ratio?

A good acid test ratio will depend on the specific industry and the characteristics of the business. In general, a ratio of 1.0 or higher is considered good, as it indicates that the business has enough liquid assets to cover its current liabilities.

However, it is important to note that the ideal ratio will vary depending on the specific industry and the business's individual circumstances.

For example, a business in a high-risk industry may have a lower ratio due to a higher number of unpaid invoices, while a business with a large number of repeat customers may have a higher ratio due to more predictable cash flows.

Overall, a good acid test ratio will depend on the specific industry and the characteristics of the business. A ratio of 1.0 or higher is generally considered good, but the ideal ratio will vary depending on the business's individual circumstances.

A bad acid test ratio is generally considered to be anything below 1.0. This indicates that the business does not have enough liquid assets to cover its current liabilities and may be at risk of not being able to meet its obligations. A ratio below 1.0 may also indicate potential financial difficulties for the business.