How to Calculate the Current and Acid Test Ratios
Learn how to calculate the current ratio and acid test ratio for A Level Business, with formulas, a worked example and what the results say about liquidity.
The current ratio is current assetscurrent liabilities\dfrac{\text{current assets}}{\text{current liabilities}}current liabilitiescurrent assets. The acid test ratio is current assets−inventorycurrent liabilities\dfrac{\text{current assets}-\text{inventory}}{\text{current liabilities}}current liabilitiescurrent assets−inventory. Both measure liquidity: a business’s ability to meet its short-term debts.
What goes into the calculations?
Current assets are resources the business expects to turn into cash or use within a year, such as cash, receivables (money owed by customers) and inventory (stock). Current liabilities are debts due within a year, such as amounts owed to suppliers. Use the figures from the business’s statement of financial position, making sure they are from the same date.
If figures are listed separately, add the short-term assets to find current assets. Do not include non-current assets such as buildings. Use only liabilities due within a year, not total liabilities. Check whether the stated current assets already include inventory before subtracting it for the acid test.
The acid test ratio removes inventory because stock may take time to sell and turn into cash. That makes it a stricter test of short-term liquidity than the current ratio.
Worked example
Suppose a business has current assets of £120,000\pounds120{,}000£120,000, including inventory of £30,000\pounds30{,}000£30,000, and current liabilities of £60,000\pounds60{,}000£60,000.
Current ratio=£120,000£60,000=2:1\text{Current ratio}=\frac{\pounds120{,}000}{\pounds60{,}000}=2:1Current ratio=£60,000£120,000=2:1 Acid test ratio=£120,000−£30,000£60,000=1.5:1\text{Acid test ratio}=\frac{\pounds120{,}000-\pounds30{,}000}{\pounds60{,}000}=1.5:1Acid test ratio=£60,000£120,000−£30,000=1.5:1This means the business has £2\pounds2£2 of current assets for every £1\pounds1£1 of current liabilities. Excluding inventory, it has £1.50\pounds1.50£1.50 for every £1\pounds1£1 owed in the short term.
The gap between the ratios shows how much the business depends on inventory for short-term cover. Slow-moving stock may make a strong current ratio misleading, while a business that receives cash promptly might cope with lower ratios. Ratios are snapshots: they do not prove cash will be available when each bill falls due.
Common exam mistake: subtract inventory for the acid test ratio only. It remains part of current assets in the current ratio. When interpreting either result, avoid claiming that one number is always “good”: consider the type of business, its past ratios and how quickly it can collect cash from customers.
