Liquidity Ratios

Question 1

Current Ratio

Answer 1

Current assets / Current Liabilities
e.g. 20/10 = 2:1

Question 2

Acid Test / Quick Ratio

Answer 2

Current Assets - Liabilities / Current Liabilities

Question 3

Advantages of Liquidity Ratios

Answer 3

• Quick and easy to calculate.
• Simple to understand - Accessible for investors, creditors and analysts.
• Easy to compare to other companies
• Allows a company to see whether they are able to cover their debts and other expenses easily (liquid) or they’ll struggle (not liquid).

Question 4

Disadvantages of Liquidity Ratios.

Answer 4

• (ST focus) - Only considers the business at one particular point in time, therefore ignores the timings of cash inflows and outflows.
• Different industries will have great differences in liquidity (depends on asset structure, dynamic business environment or not?).