Financial Statement Analysis
- Ratio Analysis of Financial Statements (Formula, Types, Excel)
- Ratio Analysis Advantages
- Ratio Analysis
- Liquidity Ratios
- Cash Ratio
- Cash Ratio Formula
- Quick Ratio
- Quick Ratio Formula
- Current Ratio
- Current Ratio Formula
- Acid Test Ratio Formula
- Defensive Interval Ratio
- Working Capital Ratio
- Working Capital Formula
- Net Working Capital Formula
- Changes in Net Working Capital
- Current Ratio vs Quick Ratio
- Bid Ask Spread
- Liquidity vs Solvency
- Solvency Ratios
- Liquidity Risk
- Altman Z Score
- Turnover Ratios
- Profitability Ratios
- Profitability Ratios Formula
- Profit Margin
- Gross Profit Margin Formula
- Operating Profit Margin Formula
- Operating Income Formula
- Net Profit Margin Formula
- EBIDTA Margin
- Earnings Per Share
- Basic EPS
- Diluted EPS
- Basic EPS vs Diluted EPS
- Return on Equity (ROE)
- Return on Capital Employed (ROCE)
- Return on Invested Capital (ROIC)
- ROIC vs ROCE
- ROE vs ROA
- Cash on Cash Return
- Return on Total Assets (ROA)
- Return on Average Capital Employed
- Capital employed Employed
- Return on Average Assets (ROAA)
- Return on Average Equity (ROAE)
- Return on Assets Formula
- Return on Equity Formula
- DuPont Formula
- Net Interest Margin Formula
- Earnings Per Share Formula
- Diluted EPS Formula
- Contribution Margin Formula
- Unit Contribution Margin
- Revenue Per Employee Ratio
- Operating Leverage
- EBIT vs EBITDA
- Capital Gains Yield
- Tax Equivalent Yield
- LTM Revenue
- Operating Expense Ratio Formula
- Overhead Ratio Formula
- Variable Costing Formula
- Capitalization Rate
- Cap Rate Formula
- Comparative Income Statement
- Capacity Utilization Rate Formula
- Total Expense Ratio Formula
- Efficiency Ratios
- Dividend Ratios
- Debt Ratios
- Debt to Equity Ratio
- Debt Coverage Ratio
- Debt Ratio
- Debt to Income Ratio Formula (DTI)
- Capital Gearing Ratio
- Capitalization Ratio
- Interest Coverage Ratio
- Times Interest Earned Ratio
- Debt Service Coverage Ratio (DSCR)
- Financial Leverage Ratio
- Financial Leverage Formula
- Net Debt Formula
- Leverage Ratios
- Operating Leverage vs Financial Leverage
- Current Yield
- Debt Yield Ratio
What is Acid Test Ratio Formula?
The formula for acid test ratio is a measure of liquidity which is calculated by dividing the summation of the most liquid assets like cash, cash equivalents, marketable securities or short-term investments and current accounts receivables by the total current liabilities. The ratio is also known as a Quick Ratio.
It can be calculated using two methods
Method 1 – Acid Test Ratio Formula
Mathematically it is represented as,
- Step 1: Firstly, all the liquid assets like cash, cash equivalents, short-term investments or marketable securities and current accounts which can be liquidated within 90 days are identified from the balance sheet and then added up.
- Step 2: Now, the acid test ratio is computed by dividing the summation of the liquid assets in Step 1 by the total current liabilities from the balance sheet.
Method 2 – Acid Test Ratio Formula
Another formula which is more popularly used calculates acid test ratio first by deducting inventory from the total current assets and then diving the value by the total current liabilities. Inventory is excluded in this formula because it is not considered to be rapidly cash convertible. Mathematically it is represented as,
- Step 1: Firstly, identify the sum of all the current assets and the inventory from the balance sheet and then deduct the inventory from the total current assets.
- Step 2: Now, the acid test ratio computed by dividing the value in Step 1 by the total current liabilities from the balance sheet.
As can be seen from above, the acid test ratio formula assesses the liquidity position of an entity by computing how well the most liquid assets can cover the current liabilities.
Examples of Acid Test Ratio Formula
Below are some of the examples to understand Acid Test Ratio in a better manner.
Acid test Ratio Formula Example #1
The following are the current assets and current liabilities of ABC Limited:
Using the above-mentioned formula the acid test ratio of ABC Limited can be calculated as:
- Acid test ratio = ($2,500 + $12,500) / ($12,500 + $1,500 + $500)
- Acid test ratio = 1.03
Acid Test Ratio Formula Example #2
The following are the current assets and current liabilities of Apple Inc. for the period ending 29 September 2018:
Using the above-mentioned formula the acid test ratio of Apple Inc for the period ending 29 September 2018 can be calculated as:
- Acid test ratio = ($25,913 + $40,388 + $48,995 + $12,087) / ($55,888 + $20,748 + $40,230)
- Acid test ratio = 1.09
Acid Test Ratio Calculator
You can use the following Acid Test Ratio Calculator.
|Acid Test Ratio Formula =||
Relevance and Uses of Acid Test Ratio Formula
The understanding of the acid test ratio is very important as it shows an entity’s potential to convert its assets into cash very quickly in order to satisfy its current liabilities. If an entity has an adequate level of liquid assets to cover its current liabilities, then it doesn’t need to liquidate any of its long-term assets to meet its current obligations. This point is of paramount importance since most businesses rely on long-term assets to generate additional revenue.
- If the acid test ratio of an entity is greater than 1.0, then the entity is considered to be financially secure and sufficiently capable to meet their short-term liabilities. The acid test ratio is more conservative measure than the popularly used current ratio as it excludes inventory which is considered to take longer to convert into cash.
- As a thumb rule, a low or decreasing trend witnessed in acid test ratio usually indicates that an entity may be having weak top-line growth, struggling to manage working capital owing to lower creditor period or higher receivable period.
- On the other hand, a high or increasing trend in acid test ratio generally means that the entity is having strong top-line growth, quickly able to convert receivables into cash and comfortable in its financial obligation coverage.
Acid Test Ratio Formula in Excel (with excel template)
Now let us take the real-life Acid Test Raio Formula example in excel of Apple Inc.’s published financial statement for the last four accounting periods.
You can easily calculate the Acid Test ratio in the template provided.
Based on publicly available financial information the Acid test ratio of Apple Inc. can be calculated for the accounting years 2015 to 2018.
Here we will use the Acid Test Ratio Formula i.e Acid test ratio = (Cash + Cash equivalents + Marketable securities + Current accounts receivables) ÷ Total current liabilities
The result will be:-
From the above table, it can be seen that the acid test ratio of Apple Inc. has been continuously greater than 1.0 during the above mentioned period which is a positive sign for any company as it signifies comfortable liquidity position.
You can download this Acid Test Ratio Formula Excel template here – Acid Test Ratio Formula Excel Template
This has been a guide to Acid Test Ratio Formula, here we discuss its uses and calculation along with practical examples of Acid Test Ratio Formula. Here we also provide you with Acid Test Ratio Calculator with downloadable excel template.