Utah Contractor Practice Exam

Which of the following statements is used to determine the "acid test"?

1. Income statement

2. Cash-flow statement

3. Balance sheet

4. Annual income tax return

The correct answer is: Balance sheet

The acid test, also known as the quick ratio, is a financial metric used to assess a company's ability to meet its short-term obligations using its most liquid assets. The formula for the acid test is calculated using data derived primarily from the balance sheet. Specifically, it involves taking the company's current assets, subtracting inventory and other non-liquid assets, and comparing the result to its current liabilities. The reason the balance sheet is the correct choice for determining the acid test is that it provides a snapshot of a company’s assets, liabilities, and equity at a specific point in time. This financial statement lists current assets, which include cash, marketable securities, and accounts receivable, that can be quickly turned into cash. By focusing on these liquid assets, the acid test allows stakeholders to evaluate liquidity more conservatively than with the current ratio, which includes inventory in its calculations. Other statements like the income statement, cash-flow statement, and annual income tax return do not present the essential information needed to accurately calculate the acid test. The income statement summarizes revenues and expenses over a period of time, while the cash-flow statement tracks the flow of cash in and out of the business. The annual income tax return provides financial data for compliance purposes but does not organize