Liquidity Ratio

Liquidity ratios
These ratios analyse the short-term financial
position of a firm and indicate the ability of
the firm to meet its short-term commitments
(current liabilities) out of its short-term
resources (current assets).
These are also known as ‘solvency ratios’.
The ratios which indicate the liquidity of a
firm are:
Current ratio
Liquidity ratio or Quick ratio or acid test ratio
 Current ratio

It is calculated by dividing current assets by current liabilities.

Current ratio = Current assets where
Current liabilities

Conventionally a current ratio of 1.5:1 is considered

satisfactory
A ratio of 5 : 1 would imply the firm has Rs 5/- of assetsto
cover every Rs 1/- in liabilities
A ratio of 0.75 : 1 would suggest the firm has only 75p in
assets available to cover every Rs.1/- it owes
 CURRENT ASSETS
include –
Inventories of raw material,
WIP, finished goods,
stores and spares,
sundry debtors/receivables,
short term loans deposits and
advances,
cash in hand and bank,
prepaid expenses,
incomes receivables and
marketable investments and
short term securities.
CURRENT LIABILITIES
include –
sundry creditors/bills payable,
outstanding expenses,
unclaimed dividend,
advances received,
incomes received in advance,
provision for taxation,
proposed dividend,
instalments of loans payable
within 12 months,
bank overdraft and cash
credit
 Quick Ratio or Liquid Ratio or Acid
Test Ratio
In Finance, The Acid –Test ratio or quick ratio measures the ability
of a company to use its near cash or quick assets to extinguish or
retire its current liabilities immediately.

Quick assets includes those current assets that can be quickly

converted to the cash.

Quick ratio = (current assets – inventories) / current liabilities

Or

Quick ratio= (cash and equivalents + marketable securities +

accounts receivable) / current liabilities
 Quick Ratio Analysis
A quick ratio of 1.5 means that a company has $1.50 of liquid assets
available to cover each $1 of current liabilities

Ideally, quick ratio should be 1:1.

If quick ratio is higher, company may keep too much cash on hand
or have a problem collecting its accounts receivable. A quick ratio
higher than 1:1 indicates that the business can meet its current
financial obligations with the available quick funds on hand.

A quick ratio lower than 1:1 may indicate that the company relies
too much on inventory or other assets to pay its short-term liabilities.
A company with a Quick Ratio of less than 1 cannot currently fully
pay back its current liabilities.