Liquidity ratioJunyup, Dachan and Rithvik

Liquidity Ratios

• Calculates how easily a firm can pay its short term financial obligations.

• 2 main liquidity ratios:• Current ratio- deals with firm’s liquid assets

and short term liabilities.• Acid Test- Ignores stock when measuring the

short term liquidity, therefore it is stricter.

Current Ratio Acid Test Ratio (quick ratio)• Deals with firm’s liquid

assets.

• Helps to reveal firm’s ability to use liquid assets to cover short term debts.

• Current ratio of 1.5-2.0 is desirable (if under- short term debts>liquid assets. If over- business may be holding current assets in unprofitable form).

• Deals with firm’s liquid assets but ignore stocks when measuring short term liquidity.

• A stricter test for liquidity.

• Ratio should be at least 1:1 otherwise firm might experience liquidity crisis. If it’s too high, firm could be holding onto too much cash rather than using it effectively.