What does the acid-test ratio indicate?

The acid-test ratio, also known as the quick ratio, is a financial metric used to assess a company's ability to meet its short-term obligations. It does so by measuring the relationship between the company’s most liquid assets (cash, cash equivalents, and receivables) and its current liabilities. By excluding inventory from current assets, the acid-test ratio provides a stringent assessment of liquidity, as inventory may not be as easily converted to cash as other assets.

A higher acid-test ratio indicates that a company has a healthier liquidity position, meaning it can more readily cover its short-term liabilities without depending on the sale of inventory. This is particularly important for investors and creditors as it reflects the company’s immediate financial health and stability.

Other options, while related to overall financial health, do not directly pertain to what the acid-test ratio measures. The ability to generate cash flow relates to operational efficiency but is broader than the immediate liquidity focus of the acid-test ratio. Profitability pertains to revenue and earnings over time, while growth potential involves future revenue prospects and market expansion, neither of which are captured by the acid-test ratio.