Multiple Choice
Which of the following ratios is most useful in evaluating a company's liquidity by excluding inventory from current assets?
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14. Financial Statement Analysis
Ratios: Quick (Acid Test) Ratio
Multiple Choice
One of the most important assumptions behind the calculation of the quick (acid test) ratio is that:
A
Inventory can be sold immediately at full value.
B
Prepaid expenses are highly liquid assets.
C
Accounts receivable can be quickly converted into cash at their stated value.
D
All current liabilities are due in more than one year.
Verified step by step guidance1
Understand the quick (acid test) ratio: It is a measure of a company's ability to meet its short-term obligations using its most liquid assets, excluding inventory.
Identify the components of the quick ratio formula: Quick assets include cash, cash equivalents, marketable securities, and accounts receivable. The formula is: .
Analyze the assumption about accounts receivable: The quick ratio assumes that accounts receivable can be quickly converted into cash at their stated value, meaning they are considered highly liquid assets.
Evaluate why inventory and prepaid expenses are excluded: Inventory is excluded because it may not be sold immediately at full value, and prepaid expenses are excluded because they are not liquid assets—they cannot be converted into cash quickly.
Understand the relevance of current liabilities: The quick ratio focuses on liabilities that are due within one year, not those due in more than one year, as it measures short-term liquidity.
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