Like the current ratio but excludes inventory, which may be hard to sell quickly. Also called the "acid test." Above 1.0 means the company can cover short-term obligations without selling inventory.
Formula
Description
A more conservative liquidity measure than the current ratio. It excludes inventory because inventory may not be quickly convertible to cash, especially in a downturn. Also called the "acid test" ratio.
Interpretation
Above 1.0 is generally safe, meaning the company can cover current liabilities without selling inventory. Below 0.5 may indicate a potential liquidity squeeze. Best used alongside the current ratio for a complete liquidity picture.
Related Quality Indicators
The percentage of revenue left after paying all operating expenses but before interest and taxes. This shows how efficiently the core business runs. Above 15% is generally strong. Consistently expanding margins signal improving business quality.
The percentage of every revenue dollar that becomes bottom-line profit after all expenses. Above 10% is strong for most industries. Persistently high net margins often indicate a company has a competitive moat protecting its business.
Profitability before the effects of debt, taxes, and depreciation. Useful for comparing companies across different tax jurisdictions and capital structures. Above 20% is generally strong. Often used in merger and acquisition analysis.
The percentage of revenue that converts to free cash flow. This is arguably the most honest profitability metric because free cash flow is difficult to manipulate. Above 10% is strong. Capital-light businesses like software companies tend to have the highest FCF margins.
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