Acid Test Ratio Analysis

Acid test ratio is strict test of liquidity. When check the quality of stone, we drop some acid on the stone. If stone will be of original marble, it will be shine. Like this, we also test company's short term position with acid test ratio. This ratio is just more deep analysis after calculating current ratio. This ratio tells the relationship between liquid assets and current liabilities. Liquid assets are different from current assets. Any asset will be liquid if it can be easily converted into cash without any loss of money within minimum time period. For calculating liquid assets, we deduct inventories and prepaid expenses from current assets.

Following is the formula of Acid Test Ratio

= Liquid Assets / Current Liabilities

For example : Quick assets are 200000 and current liabilities are Rs. 150000

Quick ratio or acid test ratio = 200000/ 150000

Components of Quick or Liquid Ratio 

Liquid Assets 

a) Cash in Hand

b) Cash at Bank

c) Sundry Debtors

d) Marketable Securities

e) Temporary Investments

Current Liabilities

Outstanding or Accrued Expenses

Bill payable

Sundry Creditors

Short term advances

Income Tax payables

Dividends payables

Bank overdraft

Point of Analysis of Acid Test or Quick or Liquid Ratio

1. When Acid Test Ratio is equal to Rule of Thumb

Rule of Thumb of acid test ratio is 1:1. If our acid test ratio is 1:1. It is good because at that time, our liquid assets are capable to pay current liabilities.

2. When Acid Test Ratio is less than Rule of Thumb

If acid ratio is 04 : 1 or less than this, this is not good because with this few amount of liquid assets, we will unable to pay our liabilities. But if our acid test ratio is little low, then there is no problem, because sometime, our stock may be liquid and we can easily sell it.

3. When Acid Test Ratio is more than Rule of Thumb

If acid test ratio is more than rule of thumb, then this is good but we should not ignore the position of our sundry debtors in this. Sometime high ratio than rule of thumb will not good, if major part of debtor is not available for quickly convertible in liquid amount.