Introduction

While the name is misleading, the acid test has nothing to do with chemistry.  Those in the accounting world are all familiar with the acid test, and it is simple to use, once you figure out what it is.  Even though accounting uses many formulas to determine exact figures, the acid test can help any company stay on top of their goals and bills.

Definition of an Acid Test

In short, an acid test is a measurement for a company to ensure they can meet their current debts if they are all due at the same time.  Also known as a quick ratio or acid test ratio, the acid test is a way for companies to ensure they have enough cash to make it through the month.  Even if all their bills and financial obligations hit at the same time, they can pay them off.  It’s an excellent way to stay on top of their bills and other finances and doesn’t require too much time to figure out.

Example of an Acid Test

The acid test ratio takes into account your cash, marketable securities, and accounts receivable, and divides them by the current liabilities.  The most common alternative formula includes the current assets minus the inventory and divides that by current liabilities.  Depending on a number of liquidities a company has, an analyst may incorporate them in the ratio.  This can benefit a company quite well, considering they may not have all the available cash at their disposal.  This formula provides an insight into whether the company can pay off their debt or not.  Companies should ensure their acid test ratio is greater than 1 to ensure they have financial stability.

Conclusion

There are many ways to measure wealth, debt, and other factors in a company, and an acid test is a valuable resource to ensure a company can meet their responsibilities.  It is a simple formula that takes different names, and it has saved companies millions of dollars.  The formula can detail if a company can pay their short-term obligations to ensure they won’t go into a financial hell.