Current Ratio : Current ratio represents the ability of the company to repay its current liabilities. Current ratio = Current assets Current liabilities Acid Test Ratio: Acid test ratio represents the capability of the company to pay its current liabilities by utilizing its quick assets, that is assets which be turned into cash within 90 days. Quick acid ratio = Quick assets Current liabilities Quick assets = Current assets − Inventory − Prepaid expenses To compute: Current ratio and acid test ratio. Solution: Given below is the computation of current ratio for Case X, Case Y and Case Z: Case X Given, Current assets are $5,200. Current liabilities are $2,000. Formula to calculate current ratio is, Current Ratio = Current Assets Current Liabilities Substitute $5,200 for current assets and $2,000 for current liabilities. Current Ratio = $ 5 , 200 $ 2 , 000 = 2.60 Case Y Given, Current assets are $3,500. Current liabilities are $1,000. Formula to calculate current ratio is, Current Ratio = Current Assets Current Liabilities Substitute $3,500 for current assets and $1,000 for current liabilities. Current Ratio = $ 3 , 500 $ 1 , 000 = 3.50 Case Z Given, Current assets are $7,410. Current liabilities are $3,800. Formula to calculate current ratio is, Current Ratio = Current Assets Current Liabilities Substitute $7,410 for current assets and $3,800 for current liabilities. Current Ratio = $ 7 , 410 $ 3 , 800 = 1.95 Given below is the computation of acid test ratio for Case X, Case Y and Case Z: Case X Given, Current liabilities are $2,000. Formula to calculate quick assets, Quick assets = Cash + Short-term investments + Current Receivable Substitute $2,000 for cash, $50 for short-term investments and $350 for current receivables. Quick assets = $ 2 , 000 + $ 50 + $ 350 = $ 2 , 400 Formula to calculate acid test ratio is, Acid test ratio = Quick Assets Current Liabilities Substitute $2,400 for quick assets and $2,000 for current liabilities. Acid test ratio = $ 2 , 400 $ 2 , 000 = 1.20 Case Y Given, Current liabilities are $1,000. Formula to calculate quick assets, Quick assets = Cash + Short-term investments + Current Receivable Substitute $110 for cash, $0 for short-term investments and $470 for current receivables. Quick assets = $ 110 + $ 0 + $ 470 = $ 580 Formula to calculate acid test ratio is, Acid test ratio = Quick Assets Current Liabilities Substitute $580 for quick assets and $1,000 for current liabilities. Acid test ratio = $ 580 $ 1 , 000 = 0.58 Case Z Given, Current liabilities are $3,800. Formula to calculate quick assets, Quick assets = Cash + Short-term investments + Current Receivable Substitute $1,000 for cash, $580 for short-term investments and $700 for current receivables. Quick assets = $ 1 , 000 + $ 580 + $ 700 = $ 2 , 280 Formula to calculate acid test ratio is, Acid test ratio = Quick Assets Current Liabilities Substitute $2,280 for quick assets and $3,800 for current liabilities. Acid test ratio = $ 2 , 280 $ 3 , 800 = 0.60 Interpretation: Case X has second highest current ratio of 2.60 and highest acid-test ratio of 1.20. Hence, it is in a good financial capability to repay its short term obligations. Case Y has highest current ratio of 3.50 but lowest acid-test ratio of 0.58. Higher current ratio or current ratio of more than 2 represents inefficient utilization of current assets. And low acid-test ratio or less than 1 acid-test ratio implies the inability of company to pay their current liabilities. Case Z has both low current ratio and low acid-test ratio which denotes the inability of the Company to repay its current liabilities. Hence, current ratio of Case X, Case Y and Case Z is 2.60, 3.50 and 1.95 respectively. Acid test ratio of X, Case Y and Case Z is 1.20, 0.58 and 0.60 respectively.

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