| acid-test ratio See quick ratio. |
What Does Acid-Test Ratio Mean?
A stringent test to determine whether a firm has enough short-term assets to cover its immediate liabilities without selling inventory; the acid-test ratio is far more strenuous than the working capital ratio because the working capital ratio allows for the inclusion of inventory assets. The acid-test ratio is calculated as follows:
Investopedia explains Acid-Test Ratio
Companies with ratios <1 cannot pay their current liabilities and therefore should be viewed with extreme caution. If the acid-test ratio is much lower than the working capital ratio, this means current assets are highly dependent on inventory. Retail stores are examples of this type of business. The term is said to have come from the method gold miners used to verify that a gold nugget was real. Unlike other metals, gold does not corrode in acid; if a nugget did not dissolve when submerged in acid, it was the real thing and was said to have passed the acid test. Today, if a company's financial statements pass the figurative acid test, this indicates the company's financial integrity.
Related Terms:
• Current Assets
• Current Liabilities
• Current Ratio
• Liability
• Working Capital
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