How to Calculate Acid Test Ratio (Quick Ratio or Liquid Ratio)
The Acid Test Ratio, also known as Quick Ratio or Liquid Ratio, is a measure of how easily a business can pay money that it owes in the near future. The ATR is expressed as the ratio of a company's liquid assets to its liquid liabilities. For example, if a company has a Quick Ratio of 0.73:1, it means that it can pay only $0.73 for every $1 that it owes to its creditors and other agents. If a business has a ratio of 2.14:1, it means that it has $2.14 to cover every $1 that it owes.
A ratio of 1:1 is considered acceptable. Ratios lower than 1:1 mean that as business does not have enough liquid assets to cover its liabilities, while ratios higher than 1:1 mean that a business is in good shape financial-wise.
The Liquid Ratio is calculated by dividing the total value of liquid assets by the total short-term liabilities. Liquid assets include cash, accounts receivable, short-term investments, and other assets that can be converted to cash quickly. It does not include inventory, since you cannot easily convert inventory into cash without taking a significant loss. Pre-paid assets are not included among the liquid assets.
A company's quick liabilities include accounts payable, future income tax due, short-term loans, and accrued expenses that have not yet been paid off. Accrued expenses can include any portion of a long-term loan that is due within a year.
Example: A company has $10,000 cash, $4,500 in receivables, $500 in marketable securities (short-term investments). It also owes $6,000 in income tax, $3,500 in accounts payable, and $1,500 in other expensees.
Its total in liquid assets is $15,000 and its total in liabilities is $11,000. Since 15000/11000 = 1.3636, the company's Quick Ratio is 1.36:1. This means it has enough reserves to pay off its immediate liabilities.
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