Why subtract inventory from current assets in the acid test ratio?

My understanding of ‘current assets’ is that they’re assets that can be liquidated within a year. My assumption about inventory is that inventory that could be similarly liquidated would be ‘quick’ and inventory that couldn’t be similarly liquidated would be ‘slow’.

So then why does the equation for the acid test ratio require subtracting inventory from current assets:

(current assets - inventory)/liabilities.

Presumably inventory has some special accounting definition?

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Hey Trent,

The quick ratio / acid test ratio is used as an indicator of how liquid a company’s finances are, particularly with an eye towards paying off their current liabilities (i.e. their short-term debt).

Inventory is generally considered a liquid asset, unless it’s something with a sales cycle longer than a year, like construction equipment or a plane. However, there’s a difference between liquidating inventory and selling it normally. Liquidation is something that often happens in bad scenarios and the inventory is sold faster at less than the normal price, potentially at a loss.

On the other hand, purchasing inventory is a common reason for companies to incur short-term debt.

So basically, the inventory sales cycle and revenue generated from selling inventory is already included in the other portion of the current assents, and the stock of inventory is needed to maintain operations. During normal times, you wouldn’t break from the standard sales cycle and liquidate the rest of your inventory ad-hoc to pay off debts.


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