Acid-Test Ratio Formula (Table of Contents)
- Acid-Test Ratio Formula
- Acid-Test Ratio Formula Calculator
- Acid-Test Ratio Formula in Excel (with Excel Template)
Acid-Test Ratio Formula
Acid-Test ratio is also known as the quick ratio. The acid-test ratio is generally used to evaluate an enterprise’s overall short term solvency or liquidity position. In simple language, it measures the capability of the company to pay its debt with its current asset. Current assets are assets that can be converted to cash within 90 days. Many times it is desirable to know the more immediate position or instant debt paying ability of a firm than that indicates by the current ratio for this acid-test ratio is used. It is relating the most liquid assets to current liabilities. Acid-test ratio formula is the sum of cash, short term investment, and current receivable minus inventory minus prepayment divided by current liabilities. It can be written as-
In short, Acid-test can be written as –
Examples of Acid-Test Ratio Formula
Let’s see an example to understand it better.
Acid-Test Ratio Formula – Example #1
Financial analyst wants to study the liquidity position of a company named HML Pvt. Ltd below its balance sheet of 2018 for analysis.
| Particulars | 2018 |
| Cash and Cash Equivalent | $50,000.00 |
| Short Term Investment | $10,000.00 |
| Receivable | $2,000.00 |
| Inventories | $3,000.00 |
| Other Current Assets | $8,900.00 |
| Total Assets | $75,918.00 |
| Total Liabilities | $36,450.00 |
The formula for Acid-test is –
Acid-Test Ratio = Cash + Short Term Investments + Current Receivables –Inventory –Prepaid Expenses / Current Liabilities
Put value from the balance sheet in the above formula.
- Acid-Test Ratio = 50 000 + 10,000 + 2,000 + 8,900 – 3,000 / 36,450
- Acid-Test Ratio = 1.86
So, the acid-test ratio of HML Pvt. Ltd is 1.86 which means it has lot of liquid assets and has high liquidity.
Acid-Test Ratio Formula – Example #2
There are three companies which have following current assets and current liabilities through which we will calculate the acid-test ratio.
| Particulars | S&S Pvt. Ltd | Anty Pvt. Ltd | Mile Pvt. Ltd |
| Current Assets | $74,125.00 | $96,321.00 | $125,610.00 |
| Inventory | $1,230.00 | $2,541.00 | $5,213.00 |
| Non-Current Liabilities | $22,000.00 | $45,000.00 | $51,000.00 |
| Total Liabilities | $35,000.00 | $51,000.00 | $62,000.00 |
| Acid-test Ratio | 5.60 | 15.63 | 10.94 |
Where,
Acid-Test Ratio = Current Assets – Inventory / Current Liability
Put value for three companies in the above formula.
S&S Pvt. Ltd:
- Acid-Test Ratio of S&S Pvt. Ltd = (74,125 – 1,230) / (35,000 – 22,000)
- Acid-Test Ratio of S&S Pvt. Ltd = 72,895 / 13000
- Acid-Test Ratio of S&S Pvt. Ltd = 5.60
Anty Pvt. Ltd:
- Acid-Test Ratio of Anty Pvt. Ltd =(96,321 – 2,541) / (51,000 – 45,000)
- Acid-Test Ratio of Anty Pvt. Ltd =93,780 / 6,000
- Acid-Test Ratio of Anty Pvt. Ltd =15.63
Mile Pvt. Ltd:
- Acid-Test Ratio of Mile Pvt. Ltd =(125,610 – 5,213) / (62,000 – 51,000)
- Acid-Test Ratio of Mile Pvt. Ltd =120,397/11,000
- Acid-Test Ratio of Mile Pvt. Ltd =10.94
This is how acid-test ratio of company is calculated and analysis is done by investors to invest in right company.
Let us see one more example to understand Acid-test ratio formula.
Acid-Test Ratio Formula – Example #3
Below is balance sheet of Ultra Pvt. Ltd for the year 2018, we have to calculate Acid-test ratio for the same.
| Cash | $60,000.00 | Account Payable | $12,000.00 |
| Market Securities | $5,000.00 | Accrued Expensed | $3,000.00 |
| Accounts Receivable | $3,000.00 | Notes Payable | $4,000.00 |
| Inventories | $1,500.00 | Loan Liabilities | $14,000.00 |
| Total Current Assets | $69,500.00 | Total Current Liabilities | $33,000.00 |
The formula for Acid-test is-
Acid-Test Ratio = Cash + Short Term Investments + Current Receivables –Inventory –Prepaid Expenses / Current Liabilities
Put the value in the above formula.
- Acid-Test Ratio = 60,000 + 5,000 + 3,000 –1,500 / 33,000
- Acid-Test Ratio = 2.01
So, acid-test ratio for Ultra Pvt. Ltd is 2.01 which mean it has lot of liquid assets and has high liquidity.
Explanation
Acid-test ratio is the ratio of the sum of the current asset by current liabilities. A current asset is the sum of all asset company has which can be convertible into cash within 90 days. Current assets are cash, short term investments, and cash equivalent cash, receivable minus inventories minus prepaid expenses divided by current liabilities. Inventories not considered in the current asset as the same cannot be converted into cash and prepaid expenses are subtracted as they cannot reverse back to cash easily. And the current liabilities are debt that the company has to repay.
If a company has a higher ratio better the company liquidity will be which result in better overall financial health. But if the ratio is very high it is also not favorable as it may possible company has excess cash but the company is not using it in a beneficial manner and it is also possible that the company’s receivable is too high and the company is not able to collect the same which imply collection problem in a company.
Acid-test ratio depends on the type of industry, its market, kind on business and its nature and financial stability of the company.
Acid-test ratio formula can be written as –
Acid-Test Ratio = Quick Assets / Current Liabilities
Where a quick asset is a current asset.
Significance and Uses of Acid-test Ratio Formula
There are many advantages and uses of Acid-test ratio formula and they are as follows-
- The acid-test formula provides an appropriate picture of liquidity of the company.
- It is most useful when the proportion of illiquid current assets to total current assets is high.
- It helps to find the financial condition of the company.
- This formula helps the investor to choose the right company for investment depending on value acid-test ratio.
- It also helps one to monitor the collection system of the company.
Disadvantages of Acid-Test Ratio Formula
There are some issues with acid-test ratio they are as follows-
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- Acid-test ratio alone is not sufficient to find liquidity of the company.
- As acid-test ratio does not include inventory it will not provide a clear picture as it may possible company have high inventories.
- In this formula, cash receivable is considered as a current asset but it may possible company will not able to collect the fund against it.
Acid-test ratio formula is very useful to know the liquidity of company and with its ratio indicate whether company will able to repay its debt or not if ratio is 1 that means quick asset is equal to current asset so company can pay its debt and if acid ratio is 2, then the company has twice quick asset than current liabilities. The high ratio is a good sign but very high ratio like 10 is not favorable.
Acid-Test Ratio Calculator
You can use the following Acid-Test Ratio Calculator
| Cash | |
| Short Term Investments | |
| Current Receivables | |
| Inventory | |
| Prepaid Expenses | |
| Current Liabilities | |
| Acid Test Ratio = | |
| Acid Test Ratio = |
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Acid-Test Ratio Formula in Excel (With Excel Template)
Here we will do the same example of the Acid-Test Ratio formula in Excel. It is very easy and simple. You need to provide the three inputs of i.e Current Assets, Inventory, and Current Liability
You can easily calculate the Acid-Test Ratio using Formula in the template provided.
Acid-test for HML Pvt. Ltd is calculated as:
Acid-test for all three Companies is calculated as:
Acid-test for Ultra Pvt. Ltd is calculated as:
Recommended Articles
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