This calculator uses the following equation:
(Cash + Market Securities + Accounts Receivable) / Current Liabilities
The Acid-Test Ratio is a stringent test to see if a company has enough short term assets to meet their current liabilities.
Any ratio equal to or greater than one means the company can pay its liabilities. A ratio less than one means the company cannot pay its current liabilities. When a company cannot pay its liabilities they may be headed for bankruptcy. The company might have the option to delay payment for some of its liabilities and get rid of unnecessary one's in order to get the company cash flow positive.
The Acid - Test Ratio is used by businesses seeking to know where they are financially. The test can help businesses realize whether they are better off then they had imagined, or if it could be doing better.
Example 1:
A Dry Cleaning shop has $2,000 cash, $100 Market Securities, and 1,500 in Accounts Receivable. Will they get a ratio over 1? The company's liabilities are $1,800.
Let's do the test!
C + AR + I / L
C = $2,000 AR = $1,500 I = $100 L = $1,800
Let's do the test!
Let's add the cash, Receivables, and short term investments.
$2,000 + $100 + $1,500 = 3600 / L
Now divide by $1,800
$3,600 / $1,800 = 2
Since 2 is greater than 1, the company has enough short term assets to meet current liabilities.
Example 2:
A Flower shop has $2,800 cash, $900 in Market Securities, and $1,300 in Receivables. The liabilities are $5,200. Will they be able to meet their current liabilities? Let's find out!
First we're going to add together the cash, receivables, and short term investments.
$2,800 + $900 + $1,300 = 5,000
Then we divide by the current liabilities which are $5,200
$5,000 / $5,200 = .96
As you can see .96 is not greater then 1. Unfortunately this Flower shop does not meet their current liabilities.