Acid-Test Ratio

The acid-test ratio, also known as the quick ratio or the cash ratio, is a liquidity ratio that measures a company's ability to pay its short-term obligations with its most liquid assets. The acid-test ratio is calculated by dividing a company's current assets minus inventory by its current liabilities.

The acid-test ratio is a more stringent measure of liquidity than the current ratio because it excludes inventory from the numerator. Inventory is a less liquid asset than cash, accounts receivable, and marketable securities because it cannot be converted into cash as quickly.

A high acid-test ratio indicates that a company has a strong liquidity position and is able to meet its short-term obligations. A low acid-test ratio, on the other hand, indicates that a company may have difficulty meeting its short-term obligations.

The acid-test ratio is a useful tool for investors and creditors to assess a company's financial health. A high acid-test ratio can give investors confidence that a company is able to meet its short-term obligations, while a low acid-test ratio may indicate that a company is at risk of default.

The acid-test ratio is also used by analysts to compare a company's liquidity to that of its peers. A company with a higher acid-test ratio than its peers is considered to be more liquid.

The acid-test ratio is a valuable tool for assessing a company's liquidity position, but it should be used in conjunction with other financial ratios to get a complete picture of a company's financial health.