Multiple Choice
The quick (acid-test) ratio is computed just like the current ratio, except that which of the following is omitted from current assets?
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14. Financial Statement Analysis
Ratios: Quick (Acid Test) Ratio
Multiple Choice
Which of the following ratios is most useful in evaluating a company's liquidity by excluding inventory from current assets?
A
Quick (Acid Test) Ratio
B
Gross Profit Margin
C
Inventory Turnover Ratio
D
Debt-to-Equity Ratio
Verified step by step guidance1
Understand the concept of liquidity: Liquidity refers to a company's ability to meet its short-term obligations using its most liquid assets. Ratios that focus on current assets are typically used to evaluate liquidity.
Identify the Quick (Acid Test) Ratio: This ratio excludes inventory from current assets because inventory is considered less liquid compared to cash, accounts receivable, or other current assets. The formula for the Quick Ratio is: Quick Ratio = (Current Assets - Inventory) / Current Liabilities.
Compare the other ratios: Gross Profit Margin measures profitability, not liquidity. Inventory Turnover Ratio evaluates how efficiently inventory is managed, but does not directly assess liquidity. Debt-to-Equity Ratio measures financial leverage, not liquidity.
Focus on the Quick Ratio: Since the Quick Ratio specifically excludes inventory and focuses on the most liquid assets, it is the most appropriate ratio for evaluating liquidity in this context.
Conclude that the Quick (Acid Test) Ratio is the correct answer because it directly addresses the company's ability to meet short-term obligations without relying on inventory.
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