An acid test, also known as a liquidity ratio, tells if a company has enough assets to cover its short-term liabilities. Cash on hand is combined with accounts receivable and short-term investments, and then divided by current liabilities.
The acid test helps businesses find out how liquid they are, as well as determine areas which need more focus and work. Should the company wish to take steps towards growth, having an idea of its financial condition is essential.
A similar kind of test is called the working capital test. It follows a similar formula, with the addition of inventory in the initial computation of assets. The resulting figure is the working capital ratio, which may also be referred to as the current ratio. Since the working capital computation includes inventory, it is considered less stringent compared to the acid test. The acid test only takes into account assets which are liquid.
