AKA: The Quick Ratio.
"Quick! How liquid are we?" The acid test, or quick ratio, is a measure of how well (or not-so-well) a company is positioned to be able to quickly pay off the bills it owes, i.e. its liabilities.
Why the quickly in there? Because the assets used to pay off the liabilities need to be quickly available assets, like cash or bank CDs or publicly traded stocks or bills the company will collect in the next 90 days or so. The company likely owns other assets, like a tractor-smelting company, but like…is it really going to sell that smelter to then pay off its bill to U.S. Steel for, uh.. steel?
Ok…the actual ratio looks like this:
(Cash + sellable securities + money people owe the company) / (liabilities)
So basically, the Quick Ratio compares your total liquid assets to how much you owe. It's important to note that you don't count your current inventory as part of your assets, as it's typically hard to sell everything you have right this moment, and then not at a big discount. The higher the quick ratio, the healthier the liquidity position.
Another good way to test your liquidity? Stand in front of a radiator and see how quickly you evaporate.
Related or Semi-related Video
Finance: What is a Balance Sheet?47 Views
finance- a la shmoop. what is a balance sheet? well it's a snapshot. a financial
reckoning of what you own ,and what you owe at a given moment in time. well note
that a balance sheet is divided into columns like this. on the left are good [balance sheet pictured]
things like things you own. on the right side are things you owe like debts or
obligations you have to pay off. well think for the balance sheet of little
brother Inc. you have total assets of $142 with current assets of a hundred
bucks .80 bucks of that current asset set is cash and twenty dollars is an IOU
from the tooth fairy ie dad ,who woke you up last night [clown next to child's bed]
replacing the tooth and since you're old enough you just winked and he said yeah
I'll get you a twenty from my wallet in the morning. note that if he'd said I'll
get it for you a year and change from now. it wouldn't be a current asset it
would be a long-term asset, because current means that a promise or a
product or whatever turns into cash within a year. you mowed the lawn for the [assets listed]
summer for mrs. garden bottom and billed her $500. she paid you four hundred
ninety dollars and still owes you ten bucks. that money lives in your balance
sheet on the assets side as an account receivable. you have four hundred ninety
seven little blue marbles as your only asset which your friend Billy has
offered you tons of times to buy for twenty four dollars so you can hold that [kids exchange marbles and money]
amount as inventory. it's an asset. since you know you deal in marbles regularly.
and you paid ten dollars for ten year rights to enter your sister Jeannie's
room anytime you want. you still have eight years to go on that paper so you'd
depreciate its value at a dollar a year worth eight bucks today. total everything [balance sheet shown]
up and you have that one hundred forty two dollars in assets on your own
personal balance. sheet okay so what about your liabilities. well you have
total liabilities of a hundred dollars. you owe Joe lunch bully thirty bucks to
learn why you'll stop hitting yourself. or rather to stop doing so you owe him
thirty bucks tomorrow and you know you'll owe him sixty bucks a year in
change from now maybe more in the future and maybe not if you grow and put on a [ laughing boy is offered cash]
few pounds. but you are conservative financially so you reserve that 60 bucks
as if it's a certain long-term debt, so it goes down there on
line 13 .you borrowed ten bucks from your boo
Amy the auditor for lunch she actually submitted to you an invoice. albeit
romantically. so you have ten bucks on line eight there .so you have one hundred
forty two dollars in total assets and a hundred dollars in total liabilities, but
wait they don't balance. oh no what shall we do ?well a balance sheet accounts for
this it's called ale and it stands for assets minus liabilities equals equity. [man gives thumbs up]
well you have assets $142 we just outlined and you can subtract your
liabilities which we just outline of a hundred bucks and you have net equity
value to your life of $42. it looks like little brother Inc doesn't have to worry
about filing for bankruptcy anytime in the near future which is good because
with Joe lunch bully in the picture, life is hard enough as it is. [kid frowns as bully pushes his own hand in his face]
Up Next
What is a Consolidated Balance Sheet? A consolidated balance sheet is one that includes all of the subsidiary companies’ aggregate balance sheets...
What is the difference between short-term and long-term liabilities? Short-term liabilities show up on the balance sheet. They need to be paid in t...
What are accounts receivable and accounts payable? Accounts receivable and payable are figures that show up on a company’s balance sheet. Account...
What is the Acid Test Ratio/Quick Ratio? The Acid Test Ratio is used to determine if a company can cover their liabilities in the short-term. It on...