Acid Test Ratio
Updated on March 19, 2023
Acid Test Ratio (ATR) is also called ‘Quick Ratio’. It is a ratio which is used to evaluate if a company’s short term assets will be able to cover its immediate and short term (current) liabilities. It represents the company’s short term financial health.
How is Acid Test Ratio calculated?
Acid Test Ratio is calculated on the basis of strength of its quick assets:
Acid Test Ratio = (Cash + Cash equivalent + Account receivable)/Current Liabilities
Current Liabilities = Debt + Payments due within 12 months
What are the limitations of Acid Test Ratio?
Acid Test Ratio comes with certain shortcomings as well, like :
a) Account Receivables might not give the correct picture of a company’s financial strength.
b) For certain businesses, where inventories are key to operations, a lower Acid Test Ratio does not indicate poor financial health of the company.
c) An Acid Test Ratio 1 is considered to be good (depending on the industry).
d) A very high Acid Test Ratio means the company has not managed its assets well.
e) In calculating Acid Test Ratio, only Quick Assets are used, that is, those which are convertible to cash within 90 days.