What is the 'AcidTest Ratio'
The acidtest ratio is aÂ strong indicator of whether a firm has sufficient shortterm assets to cover its immediate liabilities. Commonly known as the quick ratio, this metric is more robust than the current ratio, also known as the working capital ratio, since it ignores illiquid assets such as inventory.
Calculated by:
BREAKING DOWN 'AcidTest Ratio'
Companies with an acidtest ratio of less than 1 do not have the liquid assets to pay their current liabilities and should be treated with caution. If the acidtest ratio is much lower than the current ratio, it means that current assets are highly dependent on inventory.
This is not a bad sign in all cases, however, as some business models are inherently dependent on inventory.Â Retail stores, for example, may have very low acidtest ratios without necessarily being in danger. At the time of writing, WalMart Stores Inc.'s (WMT) acidtest ratio is 0.20, while Target Corp.'s (TGT) is 0.40. The companies' current ratios are 0.90 and 1.20, respectively. In such cases other metrics should be considered, such as inventory turnover. The acceptable range for an acidtest ratio will vary by industry, and comparisons are most meaningful within a given industry.Â
For most industries, the acidtest ratio should exceed 1. Then again, a very high ratio is not always an unalloyed good. It could indicate that cash has accumulated and is idle, rather than being reinvested, returned to shareholders or otherwise put to productive use. Some tech companies generate massive cash flows and accordingly have acidtest ratios as high as 7 or 8. While this is certainly better than the alternative, these companies have drawn criticism from activist investors who would prefer that shareholders receive a portion of the profits.
Acidtest Ratio Calculation
The numerator of the acidtest ratio can be defined in various ways, but the main consideration should be gaining a realistic view of the company's liquid assets. Cash and cash equivalents should definitely be included, as should shortterm investments, for example,Â marketable securities. Accounts receivable are generally included, but this is not always appropriate. In the construction industry accounts receivable may take a long time to recover, and their inclusion could make a firm's financial position seem much more secure than it is.
Another way to calculate the numerator is to take all current assets and subtract illiquid assets. Most importantly, inventory should be subtracted, keeping in mind that this will negatively skew the picture for retail businesses, as in the cases of Walmart and Target mentioned above. Other elements that appear as assets on a balance sheet should be subtracted if they cannot be used to cover liabilities in the short term, such as advances to suppliers, prepayments and deferred tax assets.Â
The denominator should include all current liabilities, which are debts and obligations that are due within one year.
It is important to note that time is not factored into the acidtest ratio. If a company's accounts payable are nearly due but its receivables won't come in for months, that company could be on much shakier ground than its ratio would indicate. The opposite can also be true.
Real World Example
A company's acidtest ratio can be calculated using its balance sheet. Below is an abbreviated version of Apple Inc.'s (AAPL) balance sheet for the quarter ended June 27, 2015, showing the components of the company's current assets and current liabilities (all figures in millions of dollars):
Â Â Â Cash and cash equivalents  15,319 
Â Â Â Shortterm marketable securities  19,384 
Â Â Â Accounts receivable, less allowance of $83  10,370 
Â Â Â Inventories  2,042 
Â Â Â Deferred tax assets  5,010 
Â Â Â Vendor nontrade receivables  9,537 
Â Â Â Other current assets  9,291 
Â Â Â Â Â Total current assets  70,953 
Â Â Â Accounts payable  26,474 
Â Â Â Accrued expenses  22,724 
Â Â Â Deferred revenue  9,088 
Â Â Â Commercial paper  4,499 
Â Â Â Current portion of longterm debt  2,500 
Â Â Â Â Â Total current liabilities  65,285 
To obtain the company's liquid current assets we add cash and cash equivalents, shortterm marketable securities, accounts receivable and vendor nontrade receivables. We thenÂ divide current liquid current assetsÂ by total current liabilities to calculate the acidtest ratio.
Apple's acidtest ratio = ( 15,319 + 19,384 + 10,370 + 9,537 ) / 65,285 = 0.84
Not everyone calculates this ratio the same. Reuters, for example, reports a quick ratio of 1.06 for Apple's most recent quarter, implying that they simply subtracted inventories from total current assets. There is no single, hardandfast method for determining a company's acidtest ratio, but it is important to understand how data providers arrive at their conclusions.
The Acidtest Gold Standard
Finally, a note on the term "acid test." One method for testing whether a metal is real gold is to apply acid to it. If certain mixtures corrode the metal, it is not gold. The more resistant to corrosion the goldÂ is, the higher the purity.Â Following the Gold Rush, the term came to refer to any test that indicates an object's authenticity, veracity, or worth. In this case, it can let you know if a shiny investment opportunity is actually fool's gold.

Liquidity
The degree to which an asset or security can be quickly bought ... 
Current Ratio
The current ratio is a liquidity ratio measuring a company's ... 
Cash Asset Ratio
The current value of marketable securities and cash, divided ... 
Quick Ratio
The quick ratio is an indicator of a companyâ€™s shortterm liquidity. ... 
Current Assets
A balance sheet account that represents the value of all assets ... 
Cash Ratio
The ratio of a company's total cash and cash equivalents to its ...

Markets
Do Your Investments Have ShortTerm Health?
If a company is strong enough to survive tough times, it is more likely to provide longterm value. 
Markets
Dynamic Current Ratio: What It Is And How To Use It
Learn why this ratio may be a good alternative to the current, cash and quick ratios. 
Markets
Liquidity Measurement Ratios
Learn about the current ratio, quick ratio, cash ratio and cash conversion cycle. 
Markets
What Are Quick Assets?
A companyâ€™s quick assets can be easily converted into cash. 
Investing
5 Basic Financial Ratios And What They Reveal
Understanding financial ratios can help investors pick strong stocks and build wealth. Here are five to know. 
Trading
Ratio Analysis
Ratio analysis is the use of quantitative analysis of financial information in a company’s financial statements. The analysis is done by comparing line items in a company’s financial ... 
Trading
6 Basic Financial Ratios And What They Reveal
These formulas can help you pick better stocks for your portfolio once you learn how to use them. 
Markets
What is the Cash Ratio?
The cash ratio is the ratio of a company's total cash and cash equivalents to its current liabilities. 
Markets
Analyze Investments Quickly With Ratios
Make informed decisions about your investments with these easy equations. 
Investing
Financial Ratios to Spot Companies Headed for Bankruptcy
Obtain information about specific financial ratios investors should monitor to get early warnings about companies potentially headed for bankruptcy.

How do I calculate the acid test ratio on a balance sheet?
Learn how to quickly calculate a company's acidtest ratio based on the figures listed on its balance sheet. See how companies ... Read Answer >> 
What is the difference between the current ratio and the acid test ratio?
Read about the main differences between the acidtest ratio and the current ratio, two measures of a company's liquidity ... Read Answer >> 
What are some alternative liquidity ratios to the cash ratio?
Learn what the cash ratio measures, and understand what two other liquidity ratios can be used by a company to replace the ... Read Answer >> 
What is the formula for calculating the current ratio?
Find out how to calculate the current ratio and what that result can tell you about a potential investment. Read Answer >> 
What are the main differences between the current ratio and the quick ratio?
Find out how the quick ratio and the current ratio can offer different views on a company's ability to pay off liabilities. Read Answer >> 
How can a company quickly increase its liquidity ratio?
Discover what high and low values in the liquidity ratio mean and what steps companies can take to improve liquidity ratios ... Read Answer >>