Acid Ratio
The acid ratio, also known as the quick ratio, is a financial metric used to measure a company’s short-term liquidity and its ability to pay off its current liabilities without relying on the sale of inventory. It is a more stringent measure of a company’s financial health compared to the current ratio, as it excludes inventory from current assets.
The acid ratio is calculated using the following formula:
\(\text{Acid Ratio (Quick Ratio)} = \frac{\text{Current Assets } – \text{ Inventories}}{\text{Current Liabilities}} \)
A higher acid ratio indicates that the company has a better financial position to cover its short-term obligations. Generally, an acid ratio of 1 or greater is considered good, as it indicates that the company has enough liquid assets to cover its current liabilities.
Example of an Acid Ratio
For example, if a company has $500,000 in current assets, $200,000 in inventory, and $300,000 in current liabilities, its acid ratio would be:
\(\text{Acid Ratio} = \frac{500,000 – 200,000}{300,000} = \frac{300,000}{300,000} = 1 \)
In this example, the company has an acid ratio of 1, which means it has enough liquid assets to cover its current liabilities without relying on the sale of inventory.
