Financial Ratio Analysis - The Acid Test Ratio

The Acid Test Ratio

The acid test ratio is also known as the liquid or the quick ratio. The idea behind this ratio is that stocks are sometimes a problem because they can be difficult to sell or use. That is, even though a supermarket has thousands of people walking through its doors every day, there are still items on its shelves that don't sell as quickly as the supermarket would like. Similarly, there are some items that will sell very well.

Nevertheless, there are some businesses whose stocks will sell or be used slowly and if those businesses needed to sell some of their stocks to try to cover an emergency, they would be disappointed. Engineering companies can have their materials in stock for as much as 9 months to a year; a greengrocer should have his stocks for no longer than 4 or 5 days - a good greengrocer anyway.

We'll look at the stock turnover ratio in detail later but here's the acid test ratio for the Carphone Warehouse.

Acid Test Ratio = (Current Assets - Stocks) : Current Liabilities

We can take the figures we need from the current ratio section and then do the calculations. Here are the acid test ratios for the year ended 31 March 2001:

Fill in this table and discuss what you find:

Acid Test Ratio For Carphone Warehouse
31 March 2001 Current Assets - Stocks: Current Liabilities _____: _____ ___: 1
25 March 2000 Current Assets - Stocks: Current Liabilities _____: _____ ___: 1

Did you get this?

We need to put the current and acid test ratios side-by-side to help us to understand what is happening to the business:

Comparison Current Acid Test
2001 1.42: 1 1.18: 1
2000 0.98: 1 0.69: 1

The fact that the differences between the current and acid test ratios are not too large tells us that the Carphone Warehouse stocks are not that large either. The stocks are worth around £52 million in 2001; but since current assets are £315 million, that's not a huge level of stock holdings.

Additionally, the acid test ratio has increased over the two year period, meaning that the Carphone Warehouse has a stronger liquidity position than it had before. Normally that is a good thing.

Section Index | Previous | Next | Next Section | Section Map