WHAT IS ACID TEST RATIO ?
The acid test ratio is a measure of a company's ability to pay off its short-term debts with its current assets, excluding inventory.
Also known as the quick ratio, the acid test ratio is a more stringent measure of liquidity than the current ratio.
The formula for calculating the acid test ratio is (Current Assets - Inventory) / Current Liabilities.
The acid test ratio helps investors and creditors determine if a company has enough liquid assets to cover its short-term obligations.
A high acid test ratio indicates that a company has a strong ability to pay off its short-term debts.
A low acid test ratio suggests that a company may have difficulty paying off its short-term debts with its current assets.
Generally, a ratio of 1 or higher is considered good, while a ratio of less than 1 may be a cause for concern.
The acid test ratio is commonly used in industries where inventory turnover is slow, such as in the manufacturing sector.
The acid test ratio does not take into account the timing of cash inflows and outflows, which can affect a company's ability to pay off its debts.
It is a useful tool for evaluating short-term liquidity, but shouldn't be the only factor considered when making investment or lending decisions.