University of Central Florida (UCF) ACG3173 Accounting for Decision-Makers Exam 3 Practice

The acid-test ratio, also known as the quick ratio, is specifically designed to measure an entity's short-term liquidity. It assesses the ability of a company to meet its short-term obligations using its most liquid assets. This ratio is calculated by taking current assets that can be quickly converted into cash (like cash and cash equivalents, accounts receivable) and dividing them by current liabilities.

A high acid-test ratio indicates that a company has sufficient liquid assets to cover its current liabilities, reflecting a strong liquidity position. This is crucial for businesses as it shows their capacity to pay off short-term debts without relying on the sale of inventory, which can be less liquid.

In contrast, the gross profit margin focuses on the profitability of a company’s sales relative to its cost of goods sold. The debt-to-equity ratio evaluates a company's financial leverage and how much of its financing is provided by debt versus equity. Return on equity measures how effectively management is using a company’s assets to create profits. Although these ratios are important for various financial analyses, they do not specifically address liquidity in the same way the acid-test ratio does.