Acid-Test Ratio Calculation for XYZ Company

Calculation of the Acid-Test Ratio

  • The acid-test ratio, also known as the quick ratio, is a financial metric that measures a company's ability to cover its short-term liabilities with its most liquid assets. It is considered a more stringent measure than the current ratio because it excludes inventory from current assets.

  • Formula:
    The acid-test ratio can be calculated using the following formula:
    \text{Acid-Test Ratio} = \frac{\text{Cash} + \text{Short-term Investments} + \text{Current Receivables}}{\text{Total Current Liabilities}}

Components of the Calculation

  • Cash:

    • Amount: $8,000

  • Short-term Investments:

    • Amount: $10,000

  • Current Receivables:

    • Amount: $12,000

  • Total Current Liabilities:

    • Amount: $22,000

Calculation Steps

  1. Add the liquid assets:

    • Cash + Short-term Investments + Current Receivables = $8,000 + $10,000 + $12,000
    • Total Liquid Assets = $30,000

  2. Calculate the acid-test ratio:

    • Using the formula:
      \text{Acid-Test Ratio} = \frac{30,000}{22,000}
    • Acid-Test Ratio = $1.36

Interpretation

  • An acid-test ratio of 1.36 means that for every dollar of current liabilities, XYZ Company has $1.36 in liquid assets to cover those liabilities.
  • This is considered a healthy liquidity position as it is above 1.0, indicating that the company can meet its short-term obligations without needing to sell inventory.