Fundamentals of Management Accounting · Ch 3 — Ratio Analysis
Liquidity Ratios
Liquidity Ratios
Liquidity Ratios measure a firm's ability to meet its short-term (current) obligations as they fall due, using its current assets. Odisha's syllabus covers three: the Current Ratio, the Quick (Acid-Test) Ratio, and the Absolute Liquid Ratio, each stricter than the one before it.
Current Ratio = Current Assets ÷ Current Liabilities
Measures overall short-term solvency; a ratio of 2 : 1 is conventionally taken as ideal (₹2 of current assets backing every ₹1 of current liabilities).
Quick (Acid-Test) Ratio = Quick Assets ÷ Current Liabilities, where Quick Assets = Current Assets − Inventory − Prepaid Expenses
A stricter test that excludes inventory (slow to convert to cash) and prepaid expenses (never convert to cash); a ratio of 1 : 1 is conventionally ideal.
Absolute Liquid Ratio = Absolute Liquid Assets ÷ Current Liabilities, where Absolute Liquid Assets = Cash and Bank + Marketable Securities (short-term investments)
The strictest liquidity test, using only assets that are cash or immediately convertible to cash; a ratio of 0.5 : 1 is conventionally taken as ideal.
Worked illustration (using the data of Section 1).
Current Assets = Inventory 2,00,000 + Trade Receivables 1,50,000 + Marketable Securities 20,000 + Cash and Bank 80,000 + Prepaid Expenses 50,000 = ₹5,00,000. Current Liabilities = ₹2,00,000.
- Current Ratio = 5,00,000 ÷ 2,00,000 = 2.5 : 1
- Quick Assets = 5,00,000 − 2,00,000 (inventory) − 50,000 (prepaid) = ₹2,50,000. Quick Ratio = 2,50,000 ÷ 2,00,000 = 1.25 : 1 …
Current Assets ÷ Current Liabilities; measures overall short-term solvency, with 2 : 1 conventional …
Quick Assets (Current Assets minus Inventory and Prepaid Expenses) ÷ Current Liabilities; a stricter liquidity test, with 1 : …
Absolute Liquid Assets (Cash and Bank plus Marketable Securities) ÷ Current Liabilities; the strictest liquidity test, with 0.5 : …