Acid-Test Ratio (Quick Ratio)

What it is

The acid-test ratio, also known as the quick ratio, measures a company’s ability to meet short-term obligations using its most liquid assets. A ratio of 1.0 or higher generally indicates the company can cover current liabilities with liquid assets; a ratio below 1.0 suggests potential difficulty.

Key takeaways

• Shows whether a company can quickly pay short-term debts using cash, short-term investments, and receivables.
• More conservative than the current ratio because it excludes inventory and other less-liquid items.
• A ratio above 1.0 is typically viewed positively, but an excessively high ratio may indicate idle cash that could be better deployed.
• Industry norms vary—retailers and inventory-heavy businesses often have lower quick ratios without being distressed.

How it works

The acid-test ratio focuses on assets that can be converted to cash in the short term. It excludes inventory, prepaid expenses, advances, and other assets that are not readily liquid. Because it ignores less-liquid items, the ratio gives a conservative view of short-term liquidity. However, it does not consider the timing of cash flows—receivables might not be collected before payables are due.

Formula and components

Acid-test ratio = (Cash + Marketable securities + Accounts receivable) / Current liabilities

Notes on components:
* Cash and cash equivalents: immediately available funds.
* Marketable securities: short-term investments easily sold.
* Accounts receivable: include only if reasonably collectible within the short term; industry practices affect collectability.
* Current liabilities: all obligations due within one year.

Practical variations:
* Some analysts compute the numerator as Total current assets minus illiquid items (notably inventory).
* Adjust the items included based on industry norms and the company’s specific balance-sheet composition.

Example

Using an abbreviated company balance-sheet example (figures in millions):

Liquid assets:
* Cash and cash equivalents: 37,119
Short-term marketable securities: 26,794
Accounts receivable: 30,213
* Vendor non-trade receivables: 35,040
Total liquid assets = 129,166

Current liabilities:
* Accounts payable: 74,632
* Other current liabilities: 49,167
Total current liabilities = 123,799

Acid-test ratio = 129,166 / 123,799 ≈ 1.04

Interpretation: The company has slightly more liquid assets than short-term obligations, suggesting adequate short-term liquidity under this calculation.

Comparison with the current ratio

• Current ratio = Current assets / Current liabilities (includes inventory and other current assets).
• Acid-test ratio excludes inventory and other less-liquid current assets, making it a stricter test of liquidity.
• Acid-test typically uses assets that can be converted to cash within about 90 days, while the current ratio can include assets convertible within a year.

Limitations and caveats

• Industry differences: Inventory-heavy businesses (e.g., retail) can have low quick ratios without being insolvent.
• Timing mismatch: The ratio does not reflect when receivables will be collected or payables will be due.
• Accounting variations: How receivables and short-term investments are reported can affect the ratio.
• High ratio concerns: Very high ratios may indicate underutilized cash that could be reinvested or returned to shareholders.

How to use it

• Compare quick ratios among companies in the same industry for meaningful insight.
• Check the components: large receivables or unusually classified assets warrant closer review.
• Use alongside other liquidity and solvency metrics (current ratio, cash flow, debt ratios) to form a fuller picture.

Bottom line

The acid-test (quick) ratio is a conservative, easy-to-calculate metric for short-term liquidity. A value above 1.0 generally indicates sufficient liquid assets to cover current liabilities, but interpretation should account for industry context, timing of cash flows, and the specific items included in the calculation.

Origin note

The term “acid-test” historically refers to applying acid to metals (like gold) to test authenticity—hence the notion of a definitive, stringent test.