Liquidity Ratios – Finance

Liquidity Ratios | Current Ratio | Quick Ratio | Cash Ratio | Finance | Management Notes

What is a liquidity ratio?

Liquidity ratio is a financial ratio that measures the liquidity position and short term solvency indicating the company’s ability to meet short-term obligations.

 

What are the types of liquidity ratios?

 

The most common ratios under this group are:

  • Current ratio

  • Liquid or quick or acid test ratio and

  • Cash ratio.

 

Current ratio (Working Capital Ratio)

The 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.

How is current ratio calculated?

Current Ratio= Current Assets /Current Liabilities


What is a high current ratio?

The higher the current ratio represents a better liquidity position of the firm.

 

What is a bad current ratio?

If it is less than the standard ratio, it shows the bad solvency position and vice-versa. For any type of business,2:1 is considered to be an adequate ratio. The low current ratio indicates that cash, marketable securities, accounts receivable inventory should be increased.

 

 

Liquid Ratio or Quick Ratio Or Acid Test Ratio

What does a quick ratio tell you?

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 a quick ratio. Quick Assets include all the current assets other than stock and prepaid.

 

What is the quick ratio formula?

Liquid or Quick Ratio= Liquid or Quick Assets/ Current Liabilities

 

What is a good quick ratio?

More or less standard ratio is not favorable for the firm. The liquid ratio of 1:1 is considered to be an adequate ratio.

Cash RatioWhat does a cash ratio mean?

Cash Ratio is calculated by dividing high liquid assets by current liabilities.

 

What is the cash ratio formula?

Cash Ratio=  (Cash +Marketable Securities)/ Current Liabilities

 

What is a good cash ratio? 

There is no ideal figure. But generally between 0.5-1 is considered as a good cash ratio. A low cash ratio may not matter if the firm can borrow on short notice.

 

 

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