Liquidity ratios - class-XII

The quick ratio is a financial ratio used to gauge a company's liquidity. The quick ratio is also known as the acid test ratio. The quick ratio compares the total amount of cash and cash equivalents + marketable securities + accounts receivable to the amount of current liabilities.

Acid test ratio = quick assets / current liabilities. All current liabilities are considered while calculating acid test ratio.

The formula for calculation of "Net working capital" is as follows:

Current ratio is the measure of liquidity of a company at the certain date. A high current ratio can be signs of problems in managing working capital. When current ratio is low and Current liabilities exceeds current assets, the company may have problems in meeting its short term obligations.

Liquidity position signify the short term solvency position of the company. Suppliers and creditors are short term liabilities, they are interested to know the liquidity position.

Liquidity ratio measures the company's ability to pay debt obligations and its margin of safety through the calculation of metrics including the current ratio and quick ratio. It also indicates cash flow positioning. It is also called as acid test ratio and quick ratio.

Quick ratio is calculated by dividing liquid current assets by total current liabilities. Liquid current assets include cash, marketable securities and receivables. Cash includes cash in hand and cash at bank.

Current Ratio = Current Assets (C.A)/ Current Liabilities (C.L)  = $2/1$

Using the Balance Sheet, the current ratio is calculated by dividing current assets by current liabilities:

Quick ratio is a liquidity ratio or short term solvency ratio. Whereas the remaining three ratios are leverage ratios.

A liquidity ratio is an indicator of whether a company's current assets will be sufficient to meet the company's obligations when they become due. The liquidity ratios include the current ratio and the acid test or quick ratio. The current ratio and quick ratio are also referred to as solvency ratios.

1. Current ratio = Current assets/Current liabilities
   
2. Quick ratio = [Current assets minus inventory]/ Current liabilities
   
3. Super quick ratio = [Cash + Marketable securities]/ Current liabilities
   
4. Basic defensive and interval ratio = [Cash + Marketable securities + Trade receivables] / Average daily expenditures

1. The liquidity ratios measure the ability of a concern to pay off its short term obligations.
2. Inventory is a part of current assets and not liquid assets.
3. Rule of thumb for acid test ratio is $1:1$
4. The amount of gross assets minus the current liabilities is equal to net capital employed. 

Ideal level of quick ratio or acid test ratio is 1:1. Usually, a high acid-test ratio is an indication that the firm is liquid has ability to meet its current or liquid liabilities in time and on the other hand a low quick ratio represents that the firm's liquidity position is not good.

Acid test ratio or Quick ratio = Quick Assets/ Current Liabilities

Current assets is a balance sheet account that represents the value of all assets that can reasonably expected to be converted into cash within one year. current assets include cash and cash equivalents, accounts receivable, marketable securities, prepaid expenses, debtors etc.

The most precise test of liquidity is "absolute liquid ratio". The ideal absolute liquidity ratio is 1:2. If the ratio is 1:2 or more than this the concern can be considered as liquid. This ratio establishes a relationship between absolute liquid assets and quick liabilities. 

Current ratio is chiefly used to assess the liquidity position of a company. Let us look at the following example.

Absolute measure ratio = absolute cash/current liabilities
Absolute cash = cash + Bank + Marketable Securities

When plant is acquired on account the fixed asset would increase and there would be increase in the creditors amount, hence the current ratio would decrease. When goods are sold on credit the stock would decrease and the debtors would increase and hence there would be no effect on current ratio.

Current ratio = Current Assets/Current liabilities

Liquidity ratio includes the following ratios :

Liquidity ratios calculate the ability of the business to pay its due to the stakeholders. Examples of liquidity ratios are Current asset ratio, Quick ratio, Cash ratio and Net working capital ratio

Issuing new shares for cash increases the cash balance (a current asset), which increases the current ratio, assuming the ratio was previously greater than 1.

If the firm has realized its debtors and paid-off its creditors to same extent then the current assets will increase and the current liabilities will decrease by the same amount and consequently the current ratio will remain unchanged.

The rule of thumb for a satisfactory current ratio is $2 : 1$. Let Current assets be $Rs. 100000$ and the Current liabilities be $Rs. 40000$

A person or firm whose liabilities exceed the value of owned assets is termed as insolvent. It is the inabilities of the company or person to pay liabilities as they become due. 

Quick ratio is the ratio of quick (or liquid) asset to current liabilties. It is expressed as:

Current ratio = Current assets / Current liabilities

Quick Ratio = [Current assets minus Inventory] / Current liabilities

1. When goods are purchased for cash the stock would increase and the cash balance would decrease and so there would be no effect on the current ratio.
2. When plant is acquired on account the fixed asset would increase and there would be increase in the creditors amount, hence the current ratio would decrease.
3. When goods are sold on credit the stock would decrease and the debtors would increase and hence there would be no effect on current ratio.
4. When debentures are converted into equity capital there would be no changes in current assets and current liabilities  and so no change in current ratio.

Quick Ratio = [Current Assets- Inventory] / [Current liabilities - Bank Overdraft and Cash credit]

1. When Redeemable debentures are issued, long term liabilities and the current assets increase,while  the current liabilities remain constant so  the current ratio would increase.
2. When old machine is sold for cash, fixed assets would decrease and the current assets would increase, while  the current liabilities remain constant so  the current ratio would increase.
3. When debentures are converted into equity capital there would be no changes in the current assets and the current liabilities and ultimately no change in the current ratio.
4. When cash is received from debtors there would be no net changes on the current assets as the cash balance would increase and the debtors balance would decrease by the same amount and hence there would no change in the current ratio.

Current ratio = Current assets/ current liabilities

Liquidity refers to both an enterprise's ability to pay short-term obligations and a company's capability to sell assets quickly to raise cash.

Quick assets are assets that can be converted to cash quickly. Typically, they include cash, accounts receivable, marketable securities, and sometimes (not usually) inventory.

The current ratio is a liquidity ratio that measures whether a firm has enough resources to meet its short-term obligations. It compares a firm's current assets to its current liabilities, and is expressed as follows: The current ratio is an indication of a firm's liquidity.

Current ratio measures the liquidity of the firm and also checks the ability of an organisation to repay to current debts. The ratio is calculated by comparing the current assets with current liabilities. 

Current Ratio = Current Assets (C.A)/ Current Liabilities (C.L)  = $2.5$

The ability of the business to pay its stakeholders when it is due is known as liquidity. And the ratios used to calculate are known as liquidity ratios and are essentially short term in nature. The following are the type of liquidity ratios:

1.  A ratio is an arithmetical relationship of one number to another number. in terms of accountancy, an accountancy ratio would be the relationship between two figures obtained from the account statement. For example Net profit ratio is the ratio of Net profit to the Net sales made.
2. Quick ratio is also known as acid test ratio because it measures the ability of the company to meet unexpected liabilities without having to depend on the sale of inventories.
3. The rule of thumb for current ratio is $2:1$, this is not a constant rule but rather relative. Whether or not the current ratio is satisfactory completely depends on the nature of business, current assets and current liabilities
4. Debt equity ratio is calculated as Total outside liabilities/ Shareholders equity and so it can be said that it is the relationship between outsiders fund and shareholders funds. 

Liquid Ratio = [Current Assets minus Stock]/ Current Liabilities

Acid test ratio or Quick ratio = Quick Assets/ Current Liabilities

Quick Ratio = [Current assets minus Inventory and prepaid expenses] /

When the current ratio is $2 : 1$ , an equal increase in current assets and current liabilities would decrease the current ratio. Let us understand this through an example;