What is the Difference Between Current Ratio and Acid Test Ratio?

The current ratio and acid-test ratio (also known as the quick ratio) are both financial metrics used to measure a company's liquidity, or its ability to meet short-term obligations. However, they differ in the types of assets they consider:

• Current Ratio: This ratio is calculated by dividing current assets by current liabilities. Current assets include cash, cash equivalents, accounts receivable, and inventory. A current ratio of 1 or more indicates that a company has enough current assets to cover its current liabilities.
• Acid-Test Ratio: This ratio is calculated as (Current Assets – Inventory) / Current Liabilities. It is more conservative than the current ratio because it excludes inventory from current assets, as inventory may not be easily or quickly converted into cash. Additionally, the acid-test ratio includes only assets that can be converted to cash within 90 days or less, while the current ratio includes those that can be converted to cash within one year.

In summary, the main differences between the current ratio and the acid-test ratio are:

1. The acid-test ratio is more conservative, as it excludes inventory from current assets.
2. The acid-test ratio includes only assets that can be converted to cash within 90 days or less, while the current ratio includes those that can be converted to cash within one year.

Comparative Table: Current Ratio vs Acid Test Ratio

Here is a table highlighting the differences between the Current Ratio and Acid Test Ratio:

Both the Current Ratio and Acid Test Ratio measure a company's short-term ability to generate enough cash to pay off its obligations, but they differ in the assets they consider. The Acid Test Ratio is considered more conservative than the Current Ratio because it excludes inventory, which may be difficult to liquidate quickly. The Current Ratio is suitable for all types of businesses, while the Acid Test Ratio is more suitable for businesses with a significant amount of inventory.