liquidity ratios

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Liquidity ratios
Liquidity Ratios
There are two main ratios that can be used to measure the liquidity of a business:
1. The current ratio
2. The 'acidtest' ratio
The current ratio
The current ratio. This measures current assets as a proportion of current liabilities. It is calculated
using the following formula:
For example, if a business has current assets of £250,000 and current liabilities of £180,000, then
the current ratio would be:
This means that for every £1 of current liabilities, the business has £1.39 of current assets available.
Ideally, the answer should be between 1.5 and 2. A figure less than 1.5 indicates that the business
may experience difficulties in meeting its shortterm debts (i.e. a liquidity crisis). An answer of more
than 2 indicates that the business may be holding cash in an unproductive and unprofitable form, and
it may be better used elsewhere.
The acid test ratio
The 'acidtest' ratio. This measures current assets less stock as a proportion of current liabilities. It
is calculated using the following formula:
Stock is excluded because a business may not be able to convert it into cash quickly. For example,
if a business has current assets less stock of £150,000 and current liabilities of £180,000, then the
current ratio would be:

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This means that for every £1 of current liabilities, the business has £0.83 of cash available at
shortnotice. Ideally, the answer should be between 1 and 1.2. A figure less than 1 indicates that the
business may experience difficulties in meeting its shortterm debts (i.e. a liquidity crisis). An answer
of more than 1.2 indicates that the business may be holding cash in an unproductive and unprofitable
form, and it may be better used elsewhere.…read more

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