The acid-test (quick) ratio is a more dependable liquidity indicator than working capital because it excludes inventory, which may not be easily converted to cash in the short term. This ratio measures a company’s ability to pay its short-term liabilities using only its most liquid assets (cash, marketable securities, and accounts receivable).
Formula for the Acid-Test Ratio:Acid-Test Ratio=Current Assets−InventoryCurrent Liabilities\text{Acid-Test Ratio} = \frac{\text{Current Assets} - \text{Inventory}}{\text{Current Liabilities}}Acid-Test Ratio=Current LiabilitiesCurrent Assets−Inventory
This ratio is more reliable than working capital since it removes inventory, which may be difficult to liquidate quickly in financial distress.
A. Acid-test (quick) ratio (Correct Answer) – This provides a stronger measure of liquidity because it excludes inventory, which might not be quickly converted to cash.
B. Average collection period – This measures the efficiency of accounts receivable collections, but it does not directly measure overall liquidity.
C. Current ratio – While this ratio is commonly used, it includes inventory, which can distort liquidity assessments if inventory is not easily sold.
D. Inventory turnover – This measures how quickly inventory is sold, but it does not directly assess liquidity.
IIA IPPF Standard 2130 – Control emphasizes liquidity monitoring as a key financial control.
COSO ERM Framework – Financial Performance Measures discusses acid-test ratio as a critical liquidity metric.
IFRS 7 – Financial Instruments Disclosures outlines the importance of liquidity risk assessments.
Explanation of Each Option:IIA References:
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