Analysis of Financial Statements Part 4

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The Acid Test ratio is a more stringent measure of Liquidity than the CR (Current Ratio).

It is expressed as a ratio of all the current assets excluding inventory to the Current Liabilities.

The term quick assets refers to CA which can be converted into cash immediately or at a short notice without decreasing of value.

CA included in the category as

(i)                Cash & bank balances

(ii) Short term marketable securities

(iii)           Debtors/ receivables

CA excluded  Inventory

ATR (Acid Test Ratio) is more superior to CR (Current Ratio)

The ratio is computed as:-

(Cash+ receivables + investments)/ (Current Liabilities)

OR

(Current Assets –Inventory) / (Current Liabilities –Short Term Bank Borrowings)

Receivables are considered to be more easily realisable and so the ratio is supposed to give a better idea of the solvency of the unit.

Now let us consider an example for better understanding as below-

Here the Stock of 100 in the Current Assets should be strike off so that we will have the below figure:-

This means for every 1 rupee Liability we only have 0.67 paise of current asset. So it is not desirable. If we plot a graph we will get the clear picture.

Though we have CA= 300 and to meet the requirement of CL=300 but if we exclude inventory we fall short of 100 and ultimately get QA=200.

In our next part we will look into Leverage Ratio/ Capitalization ratio/ Capital Structure ratio.


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