Compare the Difference Between Similar Terms

Difference Between

Home / Business / Finance / Accounting / Difference Between Current Ratio and Acid Test Ratio

Difference Between Current Ratio and Acid Test Ratio

February 9, 2017 Posted by Dili

Key Difference – Current Ratio vs Acid Test Ratio
 

Liquidity, one of the most crucial aspects of a business, refers to the convenience of converting assets into cash. Even though the main objective of a company is to be profitable, liquidity is more important in the short term in order to run smooth operations. Both current ratio and acid test ratio are considered to be very important tools in measuring the liquidity position in the company. The key difference between current ratio and acid test ratio lies in the way they are calculated; the current ratio calculation considers all the current assets in measuring liquidity, but acid test ratio excludes inventory in its calculation.

CONTENTS
1. Overview and Key Difference
2. What is Current Ratio?
3. What is Acid Test Ratio?
4. Side by Side Comparison – Current Ratio vs Acid Test Ratio

What is Current Ratio

Current Ratio is also called the ‘working capital ratio’ and calculates the company’s ability to pay off its short-term liabilities with its current assets. It is calculated as,

Current ratio = Current assets/Current liabilities

Assets whose full value can reasonably expect to be converted into cash within the accounting year are identified as current assets (e.g. cash and cash equivalents, accounts receivables, inventory, short-term investments) and short-term financial obligations whose settlement is due within the accounting period are referred to as current liabilities (e.g. accounts payable, tax payable, bank overdraft). Therefore, the current ratio expresses current debt in terms of current assets.

The ideal current ratio is considered to be 2:1, meaning that there are 2 assets to cover each liability. However, this can vary depending on the industry standards and company operations. Some financial experts even argue that there should not be such an ideal ratio. Having a very high current ratio is also not favourable as this means,

  • Company has an excess cash and cash equivalents that can be invested to make short-term returns
  • Company is holding significant inventory, thus facing related cost such as holding cost
  • Receivables take longer to pay debts owed to them, meaning cash is tied up unnecessarily

If a company borrows significantly to pay off its debt, this is not a very sustainable method in the long run since the company will be highly geared. The need to have an appropriate mixture of debt to equity is essential. Payments on current liabilities are crucial as they are due within the upcoming financial year and on time payments are essential in order to maintain healthy relationships with stakeholders.

Difference Between Current Ratio and Acid Test Ratio

Figure_1: Cash is the most liquid current asset.

What is Acid Test Ratio?

Acid test ratio is also referred to as the ‘quick ratio’ and is quite similar to the current ratio. However, it excludes inventory in its calculation of liquidity. The reason for this is that inventory is generally a less liquid current asset compared to others. This is particularly true with manufacturing and retailing organisations since they hold significant inventory, which is often their most valuable current asset. Acid Test Ratio is calculated as,

Acid test ratio = (Current assets – Inventory)/Current liabilities

The above ratio provides a better indication of the liquidity position compared to the current ratio. The ideal ratio is said to be 1:1. However, the accuracy of this ideal is considered to be questioned by financial experts.

Difference Between Current Ratio and Acid Test Ratio

Figure_2: Inventory is the most valuable current asset in the retail industry.

What is the difference between Current Ratio and Acid Test Ratio?

Current Ration vs Acid Test Ratio

The current ratio measures the ability to pay off current liabilities by using current assets. Acid test ratio measures the ability to pay off current liabilities using current assets excluding inventory.
Suitability
It is suitable for all types of companies. It is suitable for companies holding significant amount of inventory
Formula for Calculation
Current ratio = Current assets/Current liabilities Acid test ratio = (Current assets – Inventory)/Current liabilities

Reference:

“Current Ratio | Formula | Analysis | Example.” My Accounting Course. N.p., n.d. Web. 02 Feb. 2017.

Folger, Jean. “What are the main differences between the current ratio and the quick ratio?” Investopedia. N.p., 02 Sept. 2014. Web. 02 Feb. 2017.

“Ideal Current Ratio | Working Capital Ratio | Sana Securities.” Sanasecurities. N.p., n.d. Web. 02 Feb. 2017.

Image Courtesy: Pixabay

Related posts:

Difference Between Quick Ratio and Current Ratio Difference Between Liability and Asset Difference Between Liability and Debt Difference Between Liquidity and Solvency Difference Between Liability and Equity

Filed Under: Accounting Tagged With: Acid Test Ratio, Acid Test Ratio Calculation, Acid Test Ratio Definition, Acid Test Ratio Features, Acid test ratio formula, Asset, Compare Current Ratio and Acid Test Ratio, Current ratio, Current Ratio and Acid Test Ratio Differences, Current Ratio Calculation, Current Ratio Definition, Current Ratio Features, Current ratio formula, Current Ratio vs Acid Test Ratio, liability, liquidity, Quick ratio, working capital ratio

About the Author: Dili

Dili has a professional qualification in Management and Financial Accounting. She has also completed her Master’s degree in Business administration. Her areas of interests include Research Methods, Marketing, Management Accounting and Financial Accounting, Fashion and Travel.

Leave a Reply Cancel reply

Your email address will not be published. Required fields are marked *

Request Article

Featured Posts

Difference Between Coronavirus and Cold Symptoms

Difference Between Coronavirus and Cold Symptoms

Difference Between Coronavirus and SARS

Difference Between Coronavirus and SARS

Difference Between Coronavirus and Influenza

Difference Between Coronavirus and Influenza

Difference Between Coronavirus and Covid 19

Difference Between Coronavirus and Covid 19

You May Like

Difference Between HTC Thunderbolt and Motorola Atrix 4G

Difference Between G and G2

Difference Between Heptane and Hexane

Difference Between Heptane and Hexane

Difference Between Chroma Key and Green Screen

Difference Between Steel and Cast Iron

Difference Between Steel and Cast Iron

Latest Posts

  • What is the Difference Between Corpus Callosum and Corpus Luteum
  • What is the Difference Between Ciprofloxacin and Amoxicillin
  • What is the Difference Between HER2 Positive and HER2 Negative
  • What is the Difference Between Hiatal Hernia and Gallbladder Pain
  • What is the Difference Between SNP and RFLP
  • What is the Difference Between Macrolides and Tetracyclines
  • Home
  • Vacancies
  • About
  • Request Article
  • Contact Us

Copyright © 2010-2018 Difference Between. All rights reserved. Terms of Use and Privacy Policy: Legal.