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Acid Test Ratio Formula | How to Calculate Acid Test Ratio? (Examples) - YouTube
Channel: WallStreetMojo
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hello everyone hi welcome to the channel
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clicking the bell ican we have a topic
that is acid test ratio formula are also
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known as the liquidity ratio formula
like just like you have a current ratio
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we have liquidity test ratio also and it
is also known as by the name of acid
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test ratio so what we try over here to
analyze how far the company is liquid in
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terms of its current liabilities that
are standing in front of them
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well we'll try and understand this in a
very detailed format and the first and
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the foremost thing that we're going to
begin with is the formula as you can see
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the cash plus cash and cash equivalents
plus marketable securities and the
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account receivable when we add all of
this four components dividing by the
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current liabilities we get the acid test
ratio formula let's begin see the
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formula for the acid test ratio it is
basically a measure of liquidity which
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is calculated by dividing the summation
of the most liquid assets care like you
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know I'm talking about your cash and
cash equivalents right then we have
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marketable securities the short term
investments and debtors which is also
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known as your accounts receivables right
and this is divided by the total current
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liabilities now this ratio is also known
as your quick ratio now there are couple
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of methods by which this can be
calculated method number one the formula
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basically mathematically it represents
as you know the acid test ratio is equal
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to we start with cash plus
cash equivalents plus marketable securities and
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we add debtors over here and we divide
this whole thing by total current
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liabilities we divide by total current
liabilities so step number one that will
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go on with go with is you know forced all
the liquid assets like cash and cash for
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ins cash short term investments
marketable securities and your current
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accounts which can be liquidated within
90 days okay are identified from the
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balance sheet and they are to be what we
call as added up step number two now the
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asset test ratio is computed by dividing
the submission of the liquid assets in
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step number one with the current
liabilities this was the first method by
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which you can calculate there is method
number two that goes something like this
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see another formula which is more
popular or you popularly used to
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calculate the test ratio is first by
deducting the inventory from the total
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current assets so it's like your total
current assets and we'll be deducting
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less your inventory right from that will
deduct the inventory and then you will
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divide by the total current liabilities
so either you add up all things or you
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deduct from the total the inventory
straight away so inventories excluded in
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the formula because you know it is not
considered to be rapidly cash
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convertible factor mathematically it can
be represented something like this let
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me put this in this way the asset test
ratio is equal to your total current
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assets less inventory divided by the
total current liability
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when you do this you get your acid test
ratio over here this step one will be
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identify some of all the current assets
and the inventory from the balance sheet
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need to productive and the reduction of
the inventory from the total current
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assets step number two now the acid test
ratio is computed by dividing the value
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in the step number one divided by the
total current liabilities from the
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balance sheet so as can be seen from the
above the asset test ratio formula
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accees in or the liquidity position of
an entity by computing how well the most
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liquid assets can cover the current liabilities ready let me take a short example to
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make you understand this there are some
of the examples we can start with
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example number one let's say there are a
couple of details on the current asset
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side and on the current liability side
I'll put down some numbers and we'll try
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and figure out those details in a quick
fashion here we expand okay now on the
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current asset site we have cash of 2500
we have accounts receivable standing at
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12,500 and inventory standing at 15,000
and on the current liability site let's
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state the accounts payable is standing
at 12500
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accrued payables or accrued payables are
standing at 1500 and there is notes
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payable that is standing at $500 so using
the above formula the asset test ratio
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of over here let's say this is ABC
company can be computed as well we'll
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add up some of all 12500 we won't add inventory
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right so this will be the numerator
right and we'll find the denominator
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that is the current liabilities so let's
add up accounts payable accrued payables
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and notes payable let's at all of this
three so where asset test ratio
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ATR will be 15000 divided
by 14500 that goes the
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1.03 that's a good
number
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let's take another example example
number two now in this scenario let's
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say current assets and current
liabilities which are standing the first
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we have cash and cash equivalents CE
let's say standing at 25913
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short-term investments standing at
4388 and then we
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have net receivables that is standing at
48995 and
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inventory that is let's say standing at
3956 and then there is
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the other current assets that is
stunning at $12,087 let's put down
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numbers in the current liability side we
first have accounts payable that is
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$55,888 then we have the short
term or a short and current long term
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debt let's say they're standing at
$20,748 and then we
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have the other current liabilities that
is standing at $40,230
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now let's using the above mentioned you
know formula the acid test ratio over
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here of Apple Inc you know let's try and
evaluate for the period of 29 September
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2018 the acid test ratio ATR will be we
here we'll be adding 25,913
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the short of investments and
net receivables plus we'll be adding the
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other current assets except the
inventories and over here accounts
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payable will be added $55,888 + $20,748 + $40,230
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so there we have our answer
as 1.09 right so no I have discussed the
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examples so that you know you may have a
clearer idea regarding what is the real
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how this formula has been calculated I
will quickly give you the uses of the
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acid test ratio formula see the
understanding of the acid test ratio is
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very important because it shows the
entity's current liabilities and if an
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entity has adequate level of liquid
assets to cover its current liabilities
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so then it does not need to liquidate
any of its long-term assets to meet any
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current obligation but this point is the
paramount importance since you know most
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businesses rely on the long-term assets
to generate additional revenue right and
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on the other hand you know a high or the
increased trend in the acid test ratio
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generally means that the entity is
having a strong top-line growth and
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quickly able to convert the receivables
into the cash and comfortable in its
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financial obligation coverage but that's
it for this particular topic so that's
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it
for this particular topic if you have
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