The Acid-Test ratio is very similar to the "cash ratio". This ratio takes into consideration cash equivalents, marketable securities and net accounts receivables. By taking into account more liquid current assets, we can better determine how fast a company can pay off its current liabilities. The higher the ratio, the better positioned a company is to meet its maturing obligations.
The formula is:
Cash Equivalents + Marketable Securities + Net Receivables / Current Liabilities
Example:
Adequate Disclosure, Inc. plans to invest into Inadequate Disclosure, Inc. The financial analysts decide that the Acid Test Ratio is a great indicator to determine if Inadequate Disclosure, Inc. is worth an investment of $100,000. The industry average is around 1.9. Calculate the Acid Test Ratio for Inadequate Disclosure, Inc.
Cash + Marketable Securities + Accounts Receivables – Allowance for Doubtful Accounts / Accounts Payable
$75,800 +$ 86,000 + $690,000 – $58,000 / $465,000 = 1.7
Adequate Disclosure, Inc. should not invest into Inadequate Disclosure, Inc. since the Acid Test ratio indicates it is well below the industry's average.