Liquidity Ratios- Finance Flashcards
What is a current ratio?
A current ratio tells a business whether they will be able to pay off their debts due within one year with just their current assets
What current ratio should businesses aim for?
Between 1.5 and 2
What does a current ratio below 1 indicate?
Cash problems
What does a current ratio over 2 indicate?
Too much working capital
What is the formula for current ratio?
Current Assets / Current Liabilities
Which types of industries can have low current ratios and why?
Supermarkets can have low current ratios because they have lower debtors.
What is the acid test ratio?
Acid test ratio looks at whether a business is able to pay their debts without liquidating stock?
Why is it important to use an acid test ratio?
Because stock is the hardest acset to liquidate and therefor need to establish whether their debts can be paid without it
What does an acid test ratio of 1+ suggest?
It suggests that too much of its working capital is tied up in stock
How do you calculate an Acid Test Ratio?
(Current Assets - Stock) / Current Liabilities
What is a limitation of the Acid Test Ratio?
It is less relevant to a business with high stock turnover such as big supermarkets.
What does a significant deterioration in the ratio suggest?
A significant deterioration of a ratio can suggest a liquidity problem
