What does the acid test ratio measure?

The acid test ratio, also known as the quick ratio, specifically measures a company's ability to meet its current liabilities without relying on the sale of inventory. This ratio is crucial for assessing liquidity, as it provides a more conservative view of a company's financial health compared to the current ratio, which includes inventory as a current asset. By excluding inventory, the acid test focuses on the most liquid assets, such as cash, accounts receivable, and marketable securities. This is particularly important for businesses that may have a significant amount of inventory that could take time to convert into cash.

Understanding this concept helps evaluate whether an organization can comfortably manage its short-term obligations with its most liquid assets. In scenarios where inventory is not easily sellable, this ratio provides a clearer picture of financial stability in the short term.