Testing Cash Flow with the Acid Test or Quick Ratio
Part of the Bookkeeping For Dummies Cheat Sheet
In bookkeeping, the acid test or quick ratio evaluates your company’s current assets and liabilities, but it’s a stricter test of cash flow than the similar current ratio. Many lenders prefer the acid test ratio when deciding whether to give you a loan because of that strictness; it doesn’t include the inventory account in the calculation.
Calculating the acid test ratio is a two-step process:
Determine your quick assets.
Cash + Accounts Receivable + Marketable Securities = Quick assets
Calculate your quick ratio.
Quick assets ÷ Current liabilities = Quick ratio
The following is an example of an acid test ratio calculation:
$2,000 + 1,000+ 1,000 = $4,000 (quick assets)
$4,000 ÷ $2,200 = 1.8 (acid test ratio)
Lenders consider a company with an acid test ratio around 1 to be in good condition. An acid test ratio less than 1 indicates that the company may have to sell some of its marketable securities or take on additional debt until it’s able to sell more of its inventory.