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What Is the Acid-Test Ratio?
Let me explain the acid-test ratio to you directly—it's also called the quick ratio, and it pulls from a company's balance sheet to show if it can handle its short-term debts. If the ratio hits 1.0 or above, that usually means the company can pay up without issues. Anything below 1.0? It might face some trouble meeting those obligations.
Key Takeaways
You should know that the acid-test ratio, or quick ratio, reveals if a company can swiftly settle short-term debts with its most liquid assets. A ratio over 1.0 is typically positive. It's stricter than the current ratio since it skips inventory and other assets that aren't quick to turn into cash. But remember, a very high ratio isn't always ideal—it could mean the company has too much cash just sitting there instead of being used productively.
Understanding the Acid-Test Ratio
Analysts like me often turn to the acid-test ratio over the current ratio—also known as the working capital ratio—in specific cases because it disregards assets like inventory that can be tough to sell off fast. This makes it a more conservative measure.
If a company's acid-test ratio is under 1.0, it lacks enough liquid assets to cover current liabilities, so approach it with caution. When the acid-test ratio is significantly lower than the current ratio, that points to heavy reliance on inventory for current assets.
That said, this isn't always a red flag—some businesses, like retail stores, naturally depend on inventory and can have low acid-test ratios without being at risk. The right range varies by industry, and comparisons work best among similar companies.
For most sectors, the ratio should top 1.0, but a high one might signal accumulated cash that's idle rather than reinvested, returned to shareholders, or put to other uses. Some tech firms boast ratios as high as 7 or 8 due to massive cash flows, which is better than low, but they've faced pushback from investors wanting profit shares.
Calculating the Acid-Test Ratio
When calculating the acid-test ratio, focus on a realistic view of liquid assets for the numerator. Include cash, cash equivalents, and short-term investments like marketable securities. Accounts receivable usually go in, but not for every industry— in construction, for example, they might take too long to collect, skewing the picture.
The formula is straightforward: Acid-Test Ratio = (Cash + Marketable Securities + Accounts Receivable) / Current Liabilities.
You can also start with all current assets and subtract illiquid ones, especially inventory, which can distort results for retailers. Subtract other non-short-term usable assets like supplier advances, prepayments, or deferred tax assets.
The denominator covers all current liabilities—debts due within a year. Note that timing isn't built in; if payables are due soon but receivables are months away, the company might be in worse shape than the ratio suggests, or vice versa.
Example of the Acid-Test Ratio
Take Apple's balance sheet from January 27, 2022, as an example—I'll use abbreviated figures in millions. Current assets include cash and equivalents at 37,119, short-term marketable securities at 26,794, accounts receivable at 30,213, inventories at 5,876, vendor non-trade receivables at 35,040, and other current assets at 18,112, totaling 153,154.
Current liabilities: accounts payable 74,362, other current liabilities 49,167, deferred revenue 7,876, commercial paper 5,000, term debt 11,169, totaling 147,574.
To get liquid current assets, add cash and equivalents, short-term marketable securities, accounts receivable, and vendor non-trade receivables. For liabilities, add accounts payable and other current liabilities.
Apple's ratio comes out to (37,119 + 26,794 + 30,213 + 35,040) / (74,362 + 49,167) = 1.04. Keep in mind, not everyone calculates it the same way—some include or exclude different items, so check how data is derived before relying on it.
What's the Difference Between the Current and the Acid-Test Ratios?
Both the current ratio (working capital ratio) and acid-test ratio gauge a company's short-term cash generation to pay debts if due immediately. The acid-test is more conservative, ignoring inventory that's hard to liquidate quickly. It also focuses on assets convertible to cash in 90 days or less, while the current ratio looks at up to a year.
What Does the Acid-Test Ratio Tell You?
This ratio indicates if a company has or can obtain enough cash for immediate liabilities like short-term debt. Aim for over 1.0 in most industries; below that, and it lacks liquid assets, warranting caution. A big gap between acid-test and current ratios means heavy inventory dependence. But a very high ratio might show idle cash not being put to work.
How Do You Calculate the Acid-Test Ratio?
Simply divide the company's current cash, marketable securities, and total accounts receivable by its current liabilities—all from the balance sheet.
The Bottom Line
The acid-test ratio, or quick ratio, checks if a company can sell assets within 90 days to cover immediate expenses. Analysts see a ratio over 1.0 as able to pay up, and under as unable. Reliability depends on the industry, so compare similar companies. A healthy range is often 1 to 2, but it varies.
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