Acid Test Ratio or Quick Ratio.The basis for financial analysis, planning and decision making is financial statements which mainly consist of Balance Sheet and Profit and Loss Account. The profit & loss account shows the operating activities of the concern and the balance sheet depicts the balance value of the acquired assets and of liabilities at a particular point of time.
1. Acid Test Ratio :The acid test ratio is a measure of how well a company can meet its short-term financial liabilities.
In simple terms it is a good indicator that determines whether an entity has enough short-term assets to cover its immediate liabilities without selling inventory. The Quick Ratio is sometimes called the "acid-test" ratio and is one of the best measures of liquidity. The acid-test ratio is far better indicator than the working capital ratio, primarily because the working capital ratio allows for the inclusion of inventory assets as well which may not be readily realized into liquidity.
Formula to calculate :
Acid-Test Ratio = (Cash Marketable Securities Accounts Receivable) /Current liabilitiesThe Quick Ratio is a much more conservative measure of short-term liquidity than the Current Ratio. It helps answer the question: "If all sales revenues should disappear, could my business meet its current obligations with the readily convertible quick funds on hand?"Quick Ratio or Acid Test Ratio = Quick Assets /Current Liabilities
- Where, Quick Assets = Current Assets − Inventories − Prepaid expenses
- Current Liabilities = As mentioned under Current Ratio.