50 Business Challenges: No 19 – Measures (3)

The Acid Test (also known as the Quick Ratio) is a test of liquidity, in other words a company’s ability to pay its debts. It is simply

Current Assets – Stock

Current Liabilities

If the answer is less than 1, the company cannot currently pay its debts.

The word “current” is important, so that for example land assets would generally be excluded because of the time taken to realise its value. Stock is excluded since its book value may be misleading, particularly if it is last year’s style.

As with all these measures,  it is a starting point to understanding your business. You may, for example, want to think about the timing of income and outgoings. The classic for a new business is having to buy for cash, but being paid at 60 or 90 days (or even longer), The fact that your business appears to pass the acid test may mask problems.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s