‹ Subjects

Search

# Q&A - How does the acid-test ratio differ from the current ratio?

Not all assets can be turned into cash quickly or easily. Some - notably raw materials and other stocks - must first be turned into final product, then sold and the cash collected from debtors. The acid test ratio (sometimes also called the “quick ratio”) therefore adjusts the current ratio to remove the value of stocks from the current assets total.  This is because stocks are assumed to be the most illiquid part of current assets – it is harder to turn them into cash quickly.

The formula for the acid test ratio is:

An example of the calculation is shown below:

An acid test ratio of over 1.0 is generally good news; the business should able to pay its debts even if it cannot turn stocks into cash.

Some care has to be taken interpreting the acid test ratio.  The value of stocks a business needs to hold will vary considerably from industry to industry.  For example, you wouldn’t expect a firm of solicitors to carry much stock, but a major supermarket needs to carrying huge quantities at any one time.

An acid test ratio for Tesco or Asda would indicate a very low figure after taking off the value of stocks but leaving in the very high amounts owed to suppliers (trade creditors).  However, there is no suggestion that either of these two businesses has a problem being able to pay its debts!

The trick is to consider what a sensible figure is for the industry under review.  A good discipline is to find an industry average and then compare the current and acid test ratios against for the business concerned against that average.

Featured
CPD courses

### Teaching the New Edexcel A Level Business

Join the tutor2u Business team for a resource-packed day designed to fast-track your lesson planning and preparation for the new Edexcel A Level Business specification. We'll look at the key changes in teaching content, explore the new challenges of teaching this linear specification and dive into some brand new teaching resources designed specifically for the new Edexcel A Level Business course from September 2015.

### Edexcel A Level Business Year 1 (AS) Lesson Worksheets and Case Studies

This resource comprises a complete collection of editable lesson topic worksheets and exam-style case studies that are ideal for teaching individual topics for the whole Year 1 (AS) teaching content. Each lesson topic worksheet and case study has a consistent, clear and professional format and maps precisely to the specification teaching content.

£75.00

### AQA BUSS4 Revision Guide

The latest edition of Jim Riley's concise 20 page guide to key topics for BUSS4 - essential support for your BUSS4 exam

£4.00

26th June 2015

26th June 2015

26th June 2015

24th June 2015

16th June 2015

15th June 2015