Which ratio is known as the acid-test and measures immediate solvency?

Which ratio is known as the acid-test and measures immediate solvency?

• A. Current assets divided by current liabilities
• B. Cash + accounts receivable / total liabilities
• C. Quick assets / current liabilities
• D. Net working capital / current liabilities

Answer: (B)

The acid-test ratio, or quick ratio, measures immediate solvency by focusing on assets that can be quickly converted to cash to cover current obligations. It uses quick assets—cash, marketable securities, and accounts receivable—divided by current liabilities. Inventory is excluded because it isn’t reliably convertible to cash in the near term. This makes the acid-test a stricter measure than the current ratio, which uses all current assets. The idea is to see how well the firm can meet its short-term liabilities without having to sell inventory. The other formulations either include too broad an asset base (current assets), mix in total liabilities (not just short-term obligations), or combine an out-of-scope measure (net working capital) with current liabilities, so they don’t reflect immediate solvency the way the quick ratio does.

The acid-test ratio, or quick ratio, measures immediate solvency by focusing on assets that can be quickly converted to cash to cover current obligations. It uses quick assets—cash, marketable securities, and accounts receivable—divided by current liabilities. Inventory is excluded because it isn’t reliably convertible to cash in the near term. This makes the acid-test a stricter measure than the current ratio, which uses all current assets. The idea is to see how well the firm can meet its short-term liabilities without having to sell inventory. The other formulations either include too broad an asset base (current assets), mix in total liabilities (not just short-term obligations), or combine an out-of-scope measure (net working capital) with current liabilities, so they don’t reflect immediate solvency the way the quick ratio does.