This acid test ratio calculator finds the quick ratio by comparing the total of the cash, temporary marketable securities and accounts receivable to the current liabilities amount. The formula to calculate this indicator is explained below the form.
How does this acid test ratio calculator work?
In the specialty literature, the acid test ratio is the same with the quick ratio, while there are two formulas that can be used to measure the ability of a company to pay in full and in due time its current liabilities, by comparing its most short-term assets (cash and near cash current assets) to short-term liabilities or debts.
Please note that the quick ratio differs from the current ratio since the first one does not take account of some current assets categories (such as inventory) which are considered to be less liquid.
This acid test ratio calculator offers two methods to determine the quick ratio:
- First approach (see Method 1 tab) measures the proportion of the total of cash in hand and/or at bank, temporary marketable securities & account receivable against the figure of the current liabilities a company has, with the aim to help you evaluate the capacity of the entity in question to meet its current obligations:
ATR = (Cash + Accounts Receivable + Marketable securities)/Current liabilities
- Second approach (see Method 2 tab) is an alternative to the 1st equation and calculates the acid test ratio by this expression:
ATR = (Current assets – Inventory – Prepayments )/Current liabilities
The interpretation of the acid test ratio level
Acid test ratio, also known as quick ratio is an important indicator that demonstrates the liquidity level of a company, thus the larger (usually greater than 1) the ratio is the better, since it is interpreted as a positive signal that the entity being analyzed has sufficient cash to pay for its immediate obligations.
An acid test ratio of 1 (or 100%) indicates that the value of the most liquid assets a company has equal to its total short term liabilities.
On the opposite side, in case the acid test ratio level is low (usually below 1) it may indicate an increased risk of default.
However, please note that financial experts state that a too high acid test ratio (typically any level greater than 4) is neither a favorable situation since it is considered a position that is too liquid and it may indicate that the business does not use its resources appropriately either for a business development plan or to generate financial revenue and profits by placing its cash in instruments with a high rate of return.
Examples of ATR ratio calculations
Let's consider that a company has cash of $100,000, temporary marketable securities of $50,000, accounts receivable of $80,000. By adding up these 3 figures will result a total of $230,000 of liquid assets. In case its total current liabilities equal $100,000 its acid test ratio is 2.3 (or 230%).
Assuming that another business has current assets of $200,000, inventory of $20,000, prepayments of $10,000 and current liabilities of $100,000, then its quick ratio would be ($200,000 – $20,000 - $10,000)/$100,000 = 1.7 (or 170%).04 May, 2015