3.5.1 - Current and acid test ratios

Current ratio

The current ratio compares assets expected to turn into cash within a year with liabilities due within a year.

Current assets include cash, trade receivables and inventory. Trade receivables are amounts customers owe for credit sales; inventory consists of goods and materials held by the business. Current liabilities include trade payables and other obligations due within a year. Trade payables are amounts owed to suppliers. Use these categories from the statement of financial position; buildings are non-current assets and do not belong in the numerator.

In an illustrative furniture shop's statement of financial position at 31 December, current assets total USD 60,000 and current liabilities USD 30,000. The current ratio is $60{,}000/30{,}000=2$, or 2:1. It has USD 2 of current assets for each USD 1 of current liabilities. This does not mean it already has USD 2 of cash; customers may still owe money and furniture may need selling.

A ratio below 1 means recorded current liabilities exceed recorded current assets. This may signal pressure, especially if payments are imminent, but the ratio is a snapshot rather than a cash forecast. A high ratio can provide a cushion, yet it can also contain slow-moving inventory or overdue receivables. There is no single ideal current ratio for every business model.

Acid test ratio

The acid test ratio removes inventory from current assets to test liquidity without relying on selling those goods.

Inventory can take time to sell and may fetch less than its recorded value. A stricter comparison therefore excludes it, while retaining cash and trade receivables. This still assumes receivables can be collected; excluding inventory does not turn the remaining assets into guaranteed immediate cash.