acid test ratio
Another name for the quick ratio — a strict liquidity measure using only cash, short-term investments, and receivables divided by current liabilities.
Example
“The acid test ratio of 0.7 signaled the company couldn't cover current liabilities without selling inventory.”
Memory Tip
ACID TEST = like testing if it's real gold. Only uses truly liquid assets — no inventory.
Why It Matters
The acid test ratio helps you understand whether a business or individual can pay their short-term debts using only their most liquid assets. This matters because it reveals true financial health by excluding inventory and other less liquid assets that might not convert to cash quickly during emergencies.
Common Misconception
Many people think the acid test ratio and current ratio are the same thing, but the acid test ratio is actually much stricter because it excludes inventory and prepaid expenses. A company might look healthy by current ratio standards but fail the acid test ratio test if too much of their current assets are tied up in slow-moving inventory.
In Practice
Imagine a retail store with 100,000 dollars in current liabilities, 30,000 dollars in cash, 20,000 dollars in short-term investments, and 40,000 dollars in accounts receivable. The acid test ratio would be 90,000 divided by 100,000, which equals 0.9, meaning the store can cover 90 percent of its immediate obligations with only its most liquid assets.
Etymology
ACID TEST (a decisive test using acid to detect gold) RATIO. A DECISIVE TEST of liquidity using only the most liquid assets.
Common Misspellings
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