Term: ACID TEST RATIO

An accounting ratio used to determine whether a company’s current assets excluding its stock (i.e. just its debtors book and cash balance) is sufficient to pay off its current liabilities. The ratio is debtors plus cash expressed as a percentage of current liabilities. The logic is that it could be a problem to sell the company’s stock in a cash-flow crisis. This ratio has become more important since the new Companies Act (71 of 2008) came into effect in May 2011 with its doctrine of solvency and liquidity. Directors have to assert that the company has sufficient cash-flow to meet its expected expenses for the next twelve months before paying out a dividend, lending money to a director or conducting a share buy-back.

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