What is the equation for Acid-Test Ratio in accounting?
The equation for Acid-Test Ratio in accounting
Acid-Test Ratio = (Current assets – Inventory) / Current Liabilities
While this may seem as an easy answer, there is a chance of follow-up questions. For that, you can use these tips.
* Describe the relevant components of the equation.
* Discuss how these components help in measuring a company’s ability to meet its short-term financial obligations.
Provide examples throughout the answer.
Sample Answer :
“It is a financial metric used in accounting to evaluate a company’s short-term liquidity and ability to pay off its current liabilities without relying on the sale of inventory. It is also known as Quick Ratio.
Let me define the components of the equation – Acid-Test Ratio = (Current assets – Inventory) / Current Liabilities
Current Assets : These are the company’s assets. They are expected to be converted into cash or used up within the next operating cycle or one year. A few common examples include cash, marketable securities, accounts receivable, and short-term investments.
Inventory : This represents the value of the company’s stock of goods or raw materials that are held for production or resale. Since inventory may not always be quickly converted into cash, it is excluded from the quick assets used in this ratio.
Current Liabilities : These are the company’s short-term obligations that are due within the next operating cycle or one year, whichever is longer. Some examples include accounts payable, short-term debt, and accrued expenses.”
