Financial Terms ACID-TEST RATIO

# Definition of ACID-TEST RATIO

## ACID-TEST RATIO

A ratio that shows how well a company could pay its current debts using only its most liquid or â€śquickâ€ť assets. Itâ€™s a more pessimisticâ€”but also realisticâ€”measure of safety than the current ratio, because it ignores sluggish, hard-toliquidate current assets like inventory and notes receivable. Hereâ€™s the formula:
(Cash + Accounts receivable + Marketable securities) / (Current liabilities)

## Acid-test ratio

Also called the quick ratio, the ratio of current assets minus inventories, accruals, and prepaid
items to current liabilities.

See quick ratio

# Related Terms:

## acid test ratio (also called the quick ratio)

The sum of cash, accounts receivable, and short-term marketable
investments (if any) is divided by
total current liabilities to compute this ratio. Suppose that the short-term
creditors were to pounce on a business and not agree to roll over the
debts owed to them by the business. In this rather extreme scenario, the
acid test ratio reveals whether its cash and near-cash assets are enough
to pay its short-term current liabilities. This ratio is an extreme test that
is not likely to be imposed on a business unless it is in financial straits.
This ratio is quite relevant when a business is in a liquidation situation
or bankruptcy proceedings.

## Quick ratio

Indicator of a company's financial strength (or weakness). Calculated by taking current assets
less inventories, divided by current liabilities. This ratio provides information regarding the firm's liquidity
and ability to meet its obligations. Also called the acid test ratio.

## quick ratio

See acid test ratio.

## solvency

Refers to the ability of a business to pay its liabilities on time
when they come due for payment. A business may be insolvent, which
means that it is not able to pay its liabilities and debts on time. The current
ratio and acid test ratio are used to evaluate the short-term solvency

## Appraisal ratio

The signal-to-noise ratio of an analyst's forecasts. The ratio of alpha to residual standard
deviation.

## Articles of incorporation

Legal document establishing a corporation and its structure and purpose.

## Asset/equity ratio

The ratio of total assets to stockholder equity.

## Asset activity ratios

ratios that measure how effectively the firm is managing its assets.

## Asset-coverage test

A bond indenture restriction that permits additional borrowing on if the ratio of assets to
debt does not fall below a specified minimum.

## Best-interests-of-creditors test

The requirement that a claim holder voting against a plan of reorganization
must receive at least as much as he would have if the debtor were liquidated.

## Capital rationing

Placing one or more limits on the amount of new investment undertaken by a firm, either
by using a higher cost of capital, or by setting a maximum on parts of, and/or the entirety of, the capital
budget.

## Capitalization ratios

Also called financial leverage ratios, these ratios compare debt to total capitalization
and thus reflect the extent to which a corporation is trading on its equity. Capitalization ratios can be
interpreted only in the context of the stability of industry and company earnings and cash flow.

## Cash flow coverage ratio

The number of times that financial obligations (for interest, principal payments,
preferred stock dividends, and rental payments) are covered by earnings before interest, taxes, rental
payments, and depreciation.

## Cash flow from operations

A firm's net cash inflow resulting directly from its regular operations
(disregarding extraordinary items such as the sale of fixed assets or transaction costs associated with issuing
securities), calculated as the sum of net income plus non-cash expenses that were deducted in calculating net
income.

## Cash ratio

The proportion of a firm's assets held as cash.

## Common stock ratios

ratios that are designed to measure the relative claims of stockholders to earnings
(cash flow per share), and equity (book value per share) of a firm.

## Concentration account

A single centralized account into which funds collected at regional locations
(lockboxes) are transferred.

## Concentration services

Movement of cash from different lockbox locations into a single concentration
account from which disbursements and investments are made.

## Controlled foreign corporation (CFC)

A foreign corporation whose voting stock is more than 50% owned
by U.S. stockholders, each of whom owns at least 10% of the voting power.

## Conversion ratio

The number of shares of common stock that the security holder will receive from
exercising the call option of a convertible security.

## Corporation

A legal "person" that is separate and distinct from its owners. A corporation is allowed to own
assets, incur liabilities, and sell securities, among other things.

## Cost-benefit ratio

The net present value of an investment divided by the investment's initial cost. Also called
the profitability index.

## Coverage ratios

ratios used to test the adequacy of cash flows generated through earnings for purposes of
meeting debt and lease obligations, including the interest coverage ratio and the fixed charge coverage ratio.

## Current ratio

Indicator of short-term debt paying ability. Determined by dividing current assets by current
liabilities. The higher the ratio, the more liquid the company.

## Customary payout ratios

A range of payout ratios that is typical based on an analysis of comparable firms.

## Days' sales in inventory ratio

The average number of days' worth of sales that is held in inventory.

## Debt/equity ratio

Indicator of financial leverage. Compares assets provided by creditors to assets provided
by shareholders. Determined by dividing long-term debt by common stockholder equity.

## Debt ratio

Total debt divided by total assets.

## Debt-service coverage ratio

Earnings before interest and income taxes plus one-third rental charges, divided
by interest expense plus one-third rental charges plus the quantity of principal repayments divided by one
minus the tax rate.

## Declaration date

The date on which a firm's directors meet and announce the date and amount of the next
dividend.

## Dividend payout ratio

Percentage of earnings paid out as dividends.

## Dollar duration

The product of modified duration and the initial price.

## Domestic International Sales Corporation (DISC)

A U.S. corporation that receives a tax incentive for
export activities.

## Duration

A common gauge of the price sensitivity of an asset or portfolio to a change in interest rates.

Plowback rate.

## Edge corporations

Specialized banking institutions, authorized and chartered by the Federal Reserve Board
in the U.S., which are allowed to engage in transactions that have a foreign or international character. They
are not subject to any restrictions on interstate banking. Foreign banks operating in the U.S. are permitted to
organize and own and Edge corporation.

## Effective duration

The duration calculated using the approximate duration formula for a bond with an
embedded option, reflecting the expected change in the cash flow caused by the option. Measures the
responsiveness of a bond's price taking into account the expected cash flows will change as interest rates
change due to the embedded option.

## Expense ratio

The percentage of the assets that were spent to run a mutual fund (as of the last annual
statement). This includes expenses such as management and advisory fees, overhead costs and 12b-1
(distribution and advertising ) fees. The expense ratio does not include brokerage costs for trading the
portfolio, although these are reported as a percentage of assets to the SEC by the funds in a Statement of
Additional Information (SAI). the SAI is available to shareholders on request. Neither the expense ratio or the
SAI includes the transaction costs of spreads, normally incurred in unlisted securities and foreign stocks.
These two costs can add significantly to the reported expenses of a fund. The expense ratio is often termed an
Operating Expense ratio (OER).

## Expiration

The time when the option contract ceases to exist (expires).

## Expiration cycle

An expiration cycle relates to the dates on which options on a particular security expire. A
given option will be placed in 1 of 3 cycles, the January cycle, the February cycle, or the March cycle. At any
point in time, an option will have contracts with 4 expiration dates outstanding, 2 in near-term months and 2
in far-term months.

## Expiration date

The last day (in the case of American-style) or the only day (in the case of European-style)
on which an option may be exercised. For stock options, this date is the Saturday immediately following the
3rd Friday of the expiration month; however, brokerage firms may set an earlier deadline for notification of
an option holder's intention to exercise. If Friday is a holiday, the last trading day will be the preceding
Thursday.

## Fair-and-equitable test

A set of requirements for a plan of reorganization to be approved by the bankruptcy court.

## Feasible target payout ratios

Payout ratios that are consistent with the availability of excess funds to make
cash dividend payments.

## Federal Deposit Insurance Corporation (FDIC)

A federal institution that insures bank deposits.

## Financial leverage ratios

Related: capitalization ratios.

## Financial ratio

The result of dividing one financial statement item by another. ratios help analysts interpret
financial statements by focussing on specific relationships.

## Fisher's separation theorem

The firm's choice of investments is separate from its owner's attitudes towards
investments. Also refered to as portfolio separation theorem.

## Fixed asset turnover ratio

The ratio of sales to fixed assets.

## Fixed-charge coverage ratio

A measure of a firm's ability to meet its fixed-charge obligations: the ratio of
(net earnings before taxes plus interest charges paid plus long-term lease payments) to (interest charges paid
plus long-term lease payments).

## Foreign Sales Corporation (FSC)

A special type of corporation created by the Tax Reform Act of 1984 that
is designed to provide a tax incentive for exporting U.S.-produced goods.

## Freddie Mac (Federal Home Loan Mortgage Corporation)

A Congressionally chartered corporation that
purchases residential mortgages in the secondary market from S&Ls, banks, and mortgage bankers and
securitizes these mortgages for sale into the capital markets.

## Funding ratio

The ratio of a pension plan's assets to its liabilities.

## Funds From Operations (FFO)

Used by real estate and other investment trusts to define the cash flow from
trust operations. It is earnings with depreciation and amortization added back. A similar term increasingly
used is Funds Available for Distribution (FAD), which is FFO less capital investments in trust property and
the amortization of mortgages.

## Hard capital rationing

Capital rationing that under no circumstances can be violated.

## Hedge ratio (delta)

The ratio of volatility of the portfolio to be hedged and the return of the volatility of the
hedging instrument.

## Income statement (statement of operations)

A statement showing the revenues, expenses, and income (the
difference between revenues and expenses) of a corporation over some period of time.

## Interest coverage ratio

The ratio of the earnings before interest and taxes to the annual interest expense. This
ratio measures a firm's ability to pay interest.

## Interest coverage test

A debt limitation that prohibits the issuance of additional long-term debt if the issuer's
interest coverage would, as a result of the issue, fall below some specified minimum.

## Irrational call option

The implied call imbedded in the MBS. Identified as irrational because the call is
sometimes not exercised when it is in the money (interest rates are below the threshold to refinance).
Sometimes exercised when not in the money (home sold without regard to the relative level of interest rates).

## Leverage ratios

Measures of the relative contribution of stockholders and creditors, and of the firm's ability
to pay financing charges. Value of firm's debt to the total value of the firm.

## Liquidity ratios

ratios that measure a firm's ability to meet its short-term financial obligations on time.

## Long-term debt ratio

The ratio of long-term debt to total capitalization.

## Long-term debt to equity ratio

A capitalization ratio comparing long-term debt to shareholders' equity.

## Low price-earnings ratio effect

The tendency of portfolios of stocks with a low price-earnings ratio to
outperform portfolios consisting of stocks with a high price-earnings ratio.

## Liquidity ratios

ratios that measure a firm's ability to meet its short-term financial obligations on time.

## Macaulay duration

The weighted-average term to maturity of the cash flows from the bond, where the
weights are the present value of the cash flow divided by the price.

## Market value ratios

ratios that relate the market price of the firm's common stock to selected financial
statement items.

## Market-book ratio

Market price of a share divided by book value per share.

## Modified duration

The ratio of Macaulay duration to (1 + y), where y = the bond yield. Modified duration is
inversely related to the approximate percentage change in price for a given change in yield.

## Mortgage duration

A modification of standard duration to account for the impact on duration of MBSs of
changes in prepayment speed resulting from changes in interest rates. Two factors are employed: one that
reflects the impact of changes in prepayment speed or price.

## Mortgage-Backed Securities Clearing Corporation

A wholly owned subsidiary of the Midwest Stock
Exchange that operates a clearing service for the comparison, netting, and margining of agency-guaranteed
MBSs transacted for forward delivery.

## Multinational corporation

A firm that operates in more than one country.

## Negative duration

A situation in which the price of the MBS moves in the same direction as interest rates.

## Open-market operation

Purchase or sale of government securities by the monetary authorities to increase or
decrease the domestic money supply.

## Open-market purchase operation

A systematic program of repurchasing shares of stock in market
transactions at current market prices, in competition with other prospective investors.

## Operationally efficient market

Also called an internally efficient market, one in which investors can obtain
transactions services that reflect the true costs associated with furnishing those services.

## P/E ratio (PE ratio / multiple)

Assume XYZ Co. sells for \$25.50 per share and has earned \$2.55 per share this year; \$25. 50 = 10
times \$2. 55
XYZ stock sells for 10 times earnings. P/E = Current stock price divided by trailing annual earnings per
share or expected annual earnings per share.

## Payout ratio

Generally, the proportion of earnings paid out to the common stockholders as cash dividends.
More specifically, the firm's cash dividend divided by the firm's earnings in the same reporting period.

## Pension Benefit Guaranty Corporation (PBGC)

A federal agency that insures the vested benefits of
pension plan participants (established in 1974 by the ERISA legislation).

## Portfolio separation theorem

An investor's choice of a risky investment portfolio is separate from his
attitude towards risk. Related:Fisher's separation theorem.

## Possessions corporation

A type of corporation permitted under the U.S. tax code whereby a branch operation
in a U.S. possessions can obtain tax benefits as though it were operating as a foreign subsidiary.

## Price/book ratio

Compares a stock's market value to the value of total assets less total liabilities (book
value). Determined by dividing current stock price by common stockholder equity per share (book value),
adjusted for stock splits. Also called Market-to-Book.

## Price/earnings ratio (PE ratio)

Shows the "multiple" of earnings at which a stock sells. Determined by dividing current
stock price by current earnings per share (adjusted for stock splits). Earnings per share for the P/E ratio is
determined by dividing earnings for past 12 months by the number of common shares outstanding. Higher
"multiple" means investors have higher expectations for future growth, and have bid up the stock's price.

## Price/sales ratio (PS Ratio)

Determined by dividing current stock price by revenue per share (adjusted for stock splits).
Revenue per share for the P/S ratio is determined by dividing revenue for past 12 months by number of shares
outstanding.

## Private Export Funding Corporation (PEFCO)

Company that mobilizes private capital for financing the
export of big-ticket items by U.S. firms by purchasing at fixed interest rates the medium- to long-term debt
obligations of importers of U.S. products.

## Profitability ratios

ratios that focus on the profitability of the firm. Profit margins measure performance
with relation to sales. Rate of return ratios measure performance relative to some measure of size of the
investment.

## Proxy contest

A battle for the control of a firm in which the dissident group seeks, from the firm's other
shareholders, the right to vote those shareholder's shares in favor of the dissident group's slate of directors.
Also called proxy fight.

The trade association for primary dealers in U.S. government
securities, including MBSs.

## Q ratio or Tobin's Q ratio

Market value of a firm's assets divided by replacement value of the firm's assets.
Quadratic programming Variant of linear programming whereby the equations are quadratic rather than linear.

## Rate of return ratios

ratios that are designed to measure the profitability of the firm in relation to various
measures of the funds invested in the firm.

## Rational expectations

The idea that people rationally anticipate the future and respond to what they see ahead.

## Receivables turnover ratio

Total operating revenues divided by average receivables. Used to measure how
effectively a firm is managing its accounts receivable.

## Registration statement

A legal document that is filed with the SEC to register securities for public offering.

## Reserve ratios

Specified percentages of deposits, established by the Federal Reserve Board, that banks must
keep in a non-interest-bearing account at one of the twelve Federal Reserve Banks.

## Separation property

The property that portfolio choice can be separated into two independent tasks: 1)
determination of the optimal risky portfolio, which is a purely technical problem, and 2) the personal choice
of the best mix of the risky portfolio and the risk-free asset.

## Separation theorem

The value of an investment to an individual is not dependent on consumption
preferences. All investors will want to accept or reject the same investment projects by using the NPV rule,
regardless of personal preference.