LIQUIDITY RATIO

It measures the ability of the firm to meets its

obligations. The firm should ensure that it does not
suffer from lack of liquidity and at the same time it
should not have too much of liquidity. The failure of
a company to meet its obligations will result in
lawsuits leading to closure of the company. At the
same time too much of liquidity is also not good, as
idle assets earn nothing. Therefore, there is a need
for proper balance between liquidity and lack of
liquidity. The extent of liquidity and lack of liquidity
is indicated by current and quick ratio.
 A) CURRENT RATIO

• It is a ratio between current assets and current liabilities.

• Current assets include all those assets which are cash or can be
quickly converted into cash within a period of one year such as
marketable securities, stock, debtors, prepaid expenses, bills
receivable, bank and cash.
• Current liabilities are those obligations maturing within a period of
one year and include creditors, bills payable, accrued expenses,
income tax liability and long term debt maturing in the current year.
• The ratio indicates the availability of current assets in rupees for
every one rupee of current liability. It measures the firm’s short-term
solvency.
• A high current ratio indicates that the firm is
liquid and has the ability to pay its bills.
• A relatively low ratio is considered as an
indication that the firm will find difficultly in
paying its bills.
• As a conventional rule, a current ratio of 2:1 is
considered satisfactory
FORMULA:
CURRENT RATIO= CURRENT ASSETS
CURRENT LIABILITIES
 QUICK RATIO/ACID TEST RATIO

• It establishes a relationship between quick or liquid

assets and current liabilities.
• Quick assets are those assets which can be converted
into cash immediately or reasonably soon without a
loss of value and include all current assets except stock
and prepaid expenses.
• Stock normally requires sometime for realizing into
cash and its value has a tendency to fluctuate.
• Prepaid expenses are excluded, as they cannot
converted into cash.
• A quick ratio of 1:1 is considered as satisfactory.
• A higher ratio need not necessarily imply a sound
liquidity position and low ratio, a bad liquidity
position.
• This is because, all book debts need not be liquid and
cash maybe immediately needed to pay expenses.
• Therefore, the firm should compare its current ratio
and quick ratio with the industry averages to get an
idea regarding the firms relative current financial
position.
FORMULA:
QUICK RATIO= QUICK ASSETS
CURRENT LIABILITIES
Illustration. 1

The working capital of AB Ltd. has deteriorated

in recent year and now stands as under:
calculate current ratio
Current Rs Current assets Rs
liabilities

creditors 2,45,000 inventory 2,80,000

Bank loan 1,05,000 debtors 1,75,000

Cash 35,000
Solution:

Current ratio= current assets

current liabilities
= 4,90,000
3,50,000
= 1.4
Illustration No.2
From the following data calculate quick ratio
Rs Rs
stock 30,000 Sundry crs 10,000
Sundry debtors 35,000 B/P 7,500

Cash balance 10,000 debentures 75,000

B/R 15,000 Outstanding 16,000
expenses
Land& building 5,000 Tax payable 9,000

Prepaid expenses 1,00,000

Goodwill 50,000
Solution:

Quick ratio= quick assets

current liabilities
Quick assets= current assets-stock-prepaid
expenses
= 95,000-30,000-5,000=60,000
Quick ratio = 60,000
42,500
= 1.4
THANK YOU