2.3.2 Liquidity

Question 1

How do you work out the current ratio and what does it tell us?

Answer 1

Current Ratio= current assets / current liabilities

expressed in terms of X:1

It assesses whether a business has sufficient working capital to pay its short term debts.

If the answer is less than 1 it will struggle.

Question 2

How do you work out the acid test ratio and what does it tell us?

Answer 2

Current assets - inventories / current liabilities (X:1)

more secure measure of liquidity, more useful for businesses that sell large quantities of stock such as retailers.

Question 3

What are 6 ways to improve liquidity?

Answer 3

1. sell off current assets such as stock
2. delay payments
3. encourage cash sales
4. use overdraft
5. negotiate short term loans
6. get suppliers to pay without using credit