Which ratio measures a firm's ability to meet short-term debts and ignores stock in its calculation?

• A. Acid test ratio
• B. Current ratio
• C. Gearing
• D. Net profit margin

Answer: (A)

This question tests liquidity, focusing on the quick ratio, also known as the acid-test ratio. It measures how well a firm can cover its short-term debts using its most liquid assets, excluding stock. The formula is quick assets divided by current liabilities, where quick assets are cash, marketable securities, and accounts receivable. We exclude inventory because stock may not be sold quickly or may have to be discounted, so it isn’t reliable for meeting immediate obligations. This makes the acid-test ratio a stricter test of short-term liquidity than the current ratio, which includes stock. Gearing relates to debt versus equity, and net profit margin is a profitability measure, not about liquidity.