What Is the Acid-Test Ratio?

The acid-test ratio tells us whether a company can pay off its short-term liabilities with its most liquid assets. It's a good way to see how financially healthy a company is in the short term.

Understanding the Acid-Test Ratio

Think of it like this: If a company owes money in the next year, can it pay these debts using the cash it has or can easily get? This ratio helps investors and creditors understand how well a company can handle its immediate debts without having to sell its inventory, which might not be easy or quick to sell.

The Formula

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

Real-Life Example

Consider a bookstore with the following financials:

• Cash: $20,000
• Marketable Securities: $10,000
• Accounts Receivable: $30,000
• Current Liabilities: $50,000

Calculating the Acid-Test Ratio:

Acid Test = ($20,000 + $10,000 + $30,000) / $50,000 = 1.2

This means the bookstore has 1.2 times the liquid assets needed to cover its short-term debts.