The acid test ratio shows whether a company has enough short-term assets to cover its immediate liabilities without selling inventory. The higher the acid test ratio, the safer a position the company is in.
The acid test is very similar to the current ratio except that it excludes inventory because inventory is often illiquid. The nature of the inventory and the industry in which the company operates will determine if the acid test or the current ratio is more applicable.
Formula for Acid Test Ratio
\[Acid\,test\,ratio = \frac{{Current\,Assests\,-\,Inventory}}{{Current\,liablities}}\]
Example
ABC Company has currents assets in the amount of Rs.69,765, inventory in the amount of Rs.24,875, and current liabilities in the amount of Rs.28,500. This gives an acid test of 1.58. An acid test of 1.58 indicates that the company has sufficient current assets to cover its current liabilities more than one and a half times over without selling inventory.
