Liquidity Ratios(Current,Quick,Cash) | Finance I
Liquidity ratio is an financial ratio which measures the liquidity position and short term solvency indicating the company’s ability to meet short-term obligations.The most common ratios under this group are:Current ratio,Liquid or quick or acid test ratio and cash ratio.
1.Current ratio(Working Capital Ratio):
Current ratio is the relationship between current assets and current liability.The main objective of this ratio is to measure the ability of the firm to meet its short term obligations.
Current Ratio= Current Assets /Current Liabilities
Note: Higher the current ratio better is the liquidity position of the firm.If it is less than standard ratio,it shows the bad solvency position and vice-versa.For many type of business ,2:1 is considered to be an adequate ratio. Low current ratio indicates that cash ,marketable securities,accounts receivable inventory should be increased.
2.Liquid Ratio or Quick Ratio Or Acid Test Ratio:
The purpose of this ratio is to test the ability of the firm for immediate payment of current liabilities.The relationship between quick(liquid) assets and current liability is termed as quick ratio.Quick Assets includes all the current assets other than stock and prepaid.
Liquid or Quick Ratio= Liquid or Quick Assets/ Current Liabilities
Note: More or less standard ratio is not favourable for the firm. The liquid ratio of 1:1 is considered to be an adequate ratio.
Cash Ratio is calculated by dividing high liquid assets by current liabilities.
Cash Ratio= (Cash +Marketable Securities)/ Current Liabilities
Note: A low cash ratio may not matter if the firm can borrow on short notice.