Liquidity ratios

Liquidity ratios

Key terms

• Creditors and debtors

• Inventory

• Current assets

• Non-current/Fixed assets

• Current liability

• Non-current liability

• Net assets

Multiple Choice

What one of the following is not a current asset?

• Stock

• Cash in the bank

• Creditors

• Debtors

Multiple Choice

What one of the following is not a current liability?

• Machinery

• Creditors payments

• Overdraft

Multiple Choice

What is the time period for current assets?

• Within a year

• More than a year

Liquidity ratios

These ratios show how quickly an organisation can pay back its debts using it's current assets. It shows how ‘liquid’ a business is. The ratios are:

Current ratio

Acid test ratio

Current ratio

Formula is

All current assets / current liabilities

Stock + cash + debtors payments

Acid test ratio

Formula is

Current assets ( - stock) / current liabilities

Cash + debtors payments - stock

How to read a current ratio

• Will be often shown as a ratio X:1

• A ratio of above 1, means the business can pay off their current liabilities with their current assets

• They have liquidity.

• Depending on the business a current ratio of below could mean the business cannot pay it's debts.

• Generally the bigger the business, the more it can cope with a current ratio of less than 1 e.g. Sainsburys,

Multiple Choice

Current ratio: a ratio of above 1 suggests that there are more current assets than current liabilities

• TRUE

• FALSE

Multiple Choice

When working out the acid test ratio what is missing from current assets?

• Inventories

• Cash in the bank

• Debtors

A current ratio of more than 4 :1

Could mean there are problems.

• Perhaps too much cash in the bank, not being used for anything

• Maybe too many debtors who are going to cause 'cashflow' problems in the future.

• Maybe too much stock in the warehouse.

• This also means the business are paying more for warehouse space.

• 
  

The Acid Test Ratio (sometimes also called the "Quick Ratio") therefore adjusts the Current Ratio to eliminate certain current assets that are not already in cash (or "near-cash") form.

The tradition is to remove inventories from the current assets total, since inventories are assumed to be the most illiquid part of current assets – it is harder to turn them into cash quickly.

Multiple Choice

A business has a current ratio in:

2018 of 0.8

2019 of 2

What is untrue?

• It had more current assets than current liabilities in 2019

• It had more current assets than current liabilities in 2018

• It's overall performance has improved.