A retail business has Current Assets of $500,000 (which includes Inventory of $200,000) and Current Liabilities of $250,000. What is the Quick Ratio (Acid Test), and what does it indicate compared to the Current Ratio?

Answer options:

2.0:1; it indicates overall short-term solvency.

1.2:1; it indicates liquidity excluding inventory, which may be difficult to sell quickly.

0.8:1; it indicates the business cannot pay its immediate debts.

1.2:1; it indicates the proportion of inventory to total assets.

How to approach this question

Calculate Quick Ratio = (Current Assets - Inventory) / Current Liabilities. Understand that it removes inventory because inventory is the least liquid current asset.

Full Answer

B.1.2:1; it indicates liquidity excluding inventory, which may be difficult to sell quickly.✓ Correct

Quick Ratio = (Current Assets - Inventory) / Current Liabilities = ($500,000 - $200,000) / $250,000 = $300,000 / $250,000 = 1.2 (or 1.2:1). The Quick Ratio is a more stringent measure of liquidity than the Current Ratio because it excludes inventory, which cannot always be quickly converted into cash.

Common mistakes

Calculating the Current Ratio (2.0) instead of the Quick Ratio.

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