Liquidity

Question 1

What does the Current Ratio measure?

Answer 1

The Current Ratio (Working Capital Ratio) measures a business’s ability to pay its short-term debts using its current assets.

Question 2

Ideal Current Ratio

Answer 2

The ideal ratio is 1.5:1, meaning the business should have £1.50 in assets for every £1 of liabilities. Less than 1:1 indicates difficulty in paying debts.

Question 3

Example of Current Ratio Calculation

Answer 3

Current Assets = £46,000
Current Liabilities = £39,000
Current Ratio = 46,000 ÷ 39,000 = 1.18:1
Meaning: The business has just enough assets to cover its debts.

Question 4

What does the Liquid Capital Ratio measure?

Answer 4

The Liquid Capital Ratio (Acid Test Ratio) excludes inventory to show if a business can cover short-term debts with its most liquid assets.

Question 5

Ideal Liquid Capital Ratio

Answer 5

The ideal ratio is 1:1. Less than this suggests the business may struggle to pay current liabilities without selling inventory.

Question 6

Example of Liquid Capital Ratio Calculation

Answer 6

Current Assets = £46,000
Inventory = £3,800
Current Liabilities = £39,000
Liquid Capital Ratio = (46,000 - 3,800) ÷ 39,000 = 1.08:1
Meaning: The business has just enough to cover its short-term debts.