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Simple English definitions for legal terms
acid-test ratio
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A quick definition of acid-test ratio:
The acid-test ratio, also known as the quick-asset ratio, is a way to measure how easily a company can pay off its debts. It looks at the company's quick or liquid assets, such as cash and accounts receivable, and compares them to its current liabilities. This ratio helps investors and analysts understand if a company has enough cash on hand to cover its short-term debts.
A more thorough explanation:
The acid-test ratio, also known as the quick-asset ratio, is a financial ratio that measures a company's ability to pay off its current liabilities using its most liquid assets. These assets include cash, marketable securities, and accounts receivable.
The formula for calculating the acid-test ratio is:
Acid-Test Ratio = (Current Assets - Inventory) / Current Liabilities
For example, if a company has $100,000 in current assets, $20,000 of which is inventory, and $50,000 in current liabilities, the acid-test ratio would be:
($100,000 - $20,000) / $50,000 = 1.6
A ratio of 1 or higher is generally considered good, as it indicates that the company has enough liquid assets to cover its current liabilities. A ratio of less than 1 may indicate that the company may have difficulty paying off its debts.
Overall, the acid-test ratio is an important measure of a company's financial health and liquidity.