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The acid test ratio is a financial statistics that assesses the ability of a company to cover short-term obligations in the short term with its most liquid assets. A higher acid test ratio suggests a stronger liquidity position, while a lower ratio can indicate potential cash flow challenges. Investors and analysts use this statistics to assess financial health, especially in industries where inventory may not be easily converted into cash.
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The acid test ratio, also known as the rapid ratiois a liquidity ratio that is calculated by dividing the most liquid assets of a company by the current obligations. The formula is:
Aut test ratio =
Cash + tradable effects + debtors / current obligations
This calculation excludes stock and prepaid costs, because they may not be converted into cash. Tradable effects Record investments in the short term that can be easily sold, while the debtors of the accounts are owed to the company that is expected to be collected soon.
Consider a company with $ 50,000 in cash, $ 20,000 in tradable effects, $ 30,000 in debtors and $ 80,000 in current obligations for an example of how this calculation works. The acid test ratio would be: 50,000 + 20,000 + 30,000 / 80,000 = 1.25
A ratio above 1.0 indicates that liquid assets exceeds short -term obligations in the short term and is usually a sign of financial health, while a ratio under 1.0 possible liquidity restrictions suggests and can indicate poorer financial health and a higher risk. However, the results must be interpreted because their meaning varies per industry. For example, some companies work efficiently with lower ratios due to a steady cash flow.
The ZUUR test ratio helps companies and investors to assess financial stability in the short term. Companies use it to evaluate liquidity and determine whether they have sufficient cash and claims to cover immediate obligations without selling inventory or obtaining additional financing. A falling ratio in time can indicate problems with the cash flow, so that management must improve the collection of the claims or reduce the short -term debts.
Investors analyze the acid test ratio to compare companies within the same industry. A higher ratio suggests that a company has strong liquidityReducing the risk of financial need. However, an excessively high ratio can indicate that capital becomes under -utilized and can be invested again for growth. A ratio under 1.0, on the other hand, can indicate potential cash shortages, in particular in industries with unpredictable income flows.