Question

(TCO 1) To evaluate the financial operation and health of a business ratio analysis is used. (1) Provide the formula for the Acid-test (or Quick) Ratio and explain how it is computed (10 points) and (2) provide an example of how this ratio can be used in decision-making in business. (15 points)

Answer 1

The financial operation and health of the business can be evaluated with the help of ratio analysis as the ratios tells the relative relations between the two factors or variables or figures of Financial Statements through which we access the effect on one variable due to change in the other variable.

The Acid test ratio or Quick ratio is measures for us the corporation’s liquidity position in short-term to meet short-term liabilities or payables.

The formula : Acid – Text Ratio = (cash + marketable investments + AR) / Current liabilities or (Current assets – inventories) / Current Liabilities. We left out the inventories because it could not be sold out at a very short notice on appropriate valuation.

The Quick ratio is beneficial for the business decisions where liquidity is being accessed for the quick payments at short notice to purchase of essential or urgent basis material or equipments.

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