Quick ratio (acid-test) identification: the ratio obtained by dividing quick assets by current liabilities is called what in financial analysis?
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ATurnover ratio
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BAcid test ratio
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CSolvency ratio
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DNone of these.
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ECurrent ratio
Answer
Correct Answer: Acid test ratio
Explanation
Introduction / Context:The quick ratio, also known as the acid-test ratio, measures a firm’s ability to meet short-term liabilities using its most liquid assets, excluding inventories and prepaid items. It is stricter than the current ratio and is widely used to evaluate immediate liquidity under conservative assumptions.
Given Data / Assumptions:
- Quick assets typically include cash, cash equivalents, marketable securities, and receivables.
- Current liabilities include obligations due within one year (e.g., payables, current portion of long-term debt).
- Inventories are excluded because they may not be quickly realisable at book value.
Concept / Approach:Formula: Quick ratio = Quick assets / Current liabilities. By focusing on near-cash items, it assesses whether the firm can meet obligations without relying on inventory sales or new financing. A ratio near or above 1.0 is often considered comfortable, though industry context matters greatly.
Step-by-Step Solution:
Identify quick assets: Cash + Marketable securities + Accounts receivable.Identify current liabilities: Payables + Accrued expenses + Short-term debt.Compute Quick ratio = (Quick assets) / (Current liabilities) and interpret against peer norms.Verification / Alternative check:
Cross-check with current ratio to see the impact of inventory; a large gap suggests heavy reliance on inventory to cover liabilities.Why Other Options Are Wrong:
Turnover ratio relates to efficiency (e.g., inventory turns), not liquidity per se.Solvency ratio typically addresses long-term leverage and debt-paying ability.'None of these' is incorrect because the standard term is acid-test ratio.Common Pitfalls:
Counting slow or doubtful receivables as fully liquid; ignoring seasonality that temporarily distorts the metric.Final Answer:
Acid test ratio