The Acid-Test Ratio, also known as the quick ratio or the liquidity ratio, is a financial metric that assesses a company’s short-term liquidity and its ability to meet its short-term obligations. It’s a more stringent measure than the current ratio because it excludes inventory from current assets. The acid-test ratio is particularly useful for evaluating a company’s ability to pay off its current liabilities without relying on the sale of inventory.

The formula for the Acid-Test Ratio is as follows:

\[ \text{Acid-Test Ratio} = \frac{\text{Current Assets} – \text{Inventory}}{\text{Current Liabilities}} \]

The components of the formula are defined as follows:

– **Current Assets:** Assets that are expected to be converted into cash or used up within one year. This typically includes cash, accounts receivable, and short-term investments.

– **Inventory:** This represents goods that a company has in stock and plans to sell. Since inventory may take time to convert to cash, it is excluded from the quick ratio.

– **Current Liabilities:** Obligations that are expected to be settled within one year, such as accounts payable, short-term debt, and other current liabilities.

A ratio greater than 1 indicates that the company has enough quick assets to cover its short-term liabilities, suggesting good short-term financial health. Conversely, a ratio less than 1 may indicate potential liquidity problems.

The acid-test ratio is a valuable tool for creditors and investors because it provides insight into a company’s ability to handle its immediate financial obligations. However, it’s important to note that different industries may have different standards for what is considered an acceptable acid-test ratio. Additionally, it’s usually more meaningful to compare the ratio over time or against industry benchmarks rather than assessing it in isolation.