Liquidity ratios

It measures the availability of cash and other liquid assets to meet the current liabilities of the firm.

Current Ratio

The current ratio compares total current assets to total current liabilities and is intended to indicate whether there are sufficient short-term assets to meet the short-term liabilities.

Current assets: Current liabilities

The ratio when calculated may be expressed as either a ratio or 1, with current liabilities being set to 1, or as ‘number of times’, representing the relative size of the amount of total current assets compared with total current liabilities.

A ratio of 2:1 or current assets as 2 times is considered to be healthy for a business.

Acid test ratio

It is quite similar to Current ratio. The only difference in the items involved between the two ratios is that the acid test ratio or quick ratio does not include stock.


Acid Test ratio
=
Current assets-Stock
Current liabilities

An acid test ratio 1:1 is considered as healthy. If it is below 1 it suggest the business has insufficient liquid assets to meet their short term liabilities.

 

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