acid test ratio: calculation and interpretation

10.2 Analysis of Published Accounts – Liquidity Ratios

Acid Test Ratio (Quick Ratio) 📊

The acid test ratio tells us how well a company can meet its short‑term obligations using only its most liquid assets. Think of it as a quick “battery check” for a business – can it pay its bills without having to sell inventory?

Formula

\$ \displaystyle \text{Acid Test Ratio} = \frac{\text{Cash} + \text{Marketable Securities} + \text{Accounts Receivable}}{\text{Current Liabilities}} \$

Quick Assets = Cash + Marketable Securities + Accounts Receivable


Current Liabilities = Debts due within one year

How to Calculate – Step by Step 🧠

  1. Find Cash from the balance sheet.

  2. Add Marketable Securities (short‑term investments).

  3. Add Accounts Receivable (money owed by customers).

  4. Sum these to get Quick Assets.

  5. Locate Current Liabilities (e.g., accounts payable, short‑term loans).

  6. Divide Quick Assets by Current Liabilities.

Example

ItemAmount (£)
Cash150,000
Marketable Securities50,000
Accounts Receivable200,000
Quick Assets400,000
Current Liabilities250,000
Acid Test Ratio1.60

Interpretation: 1.60 > 1, so the company can comfortably cover its short‑term debts without relying on inventory sales.

Interpretation & What It Means for the Business 🚀

  • Ratio > 1 – Quick assets exceed current liabilities. The firm is in good shape to pay off debts quickly.

  • Ratio = 1 – Quick assets exactly cover current liabilities. The company is just breaking even on liquidity.

  • Ratio < 1 – Quick assets are less than current liabilities. The firm may need to sell inventory or find other funding to meet obligations.

Remember: the acid test is stricter than the current ratio because it excludes inventory, which may not be sold quickly.

Exam Tip

• Always exclude inventory when calculating the acid test ratio.


• Show the formula in your answer to demonstrate understanding.


• Interpret the ratio in context – what does a value of 0.8 or 1.5 tell you about the company’s liquidity?


• Use an example from the case study or a fictional company to illustrate your calculation.