Liquidity ratios indicate the ease that a company has to turn assets into cash. A business must be able to perform positively in relation to
profitability but must also be able to pay creditors, expenses and loans as they fall due. The Current and Acid Test Ratios are the best
known measures of this financial strength. These are calculated as follows:
1. Current Ratio = Current Assets /Current Liabilities
Example (Company Z) : 2012: 2: 1 2011: 1.9:1 2010: 1.7:1
The Current Ratio compares the relationship between current assets and current liabilities and is intended to indicate whether the
business has sufficient current assets to meet the current liabilities. The widely accepted standard holds that current ratio should be at
2:1 that is the current assets should meet current liabilities by at least twice. The above example shows that Company Z has improved
its liquidity from 2010 to 2012.
2. Acid Test Ratio = Current Assets – Stock/Current Liabilities
Example (Company Z) : 2012: 1: 1 2011: .9:1 2010: .7:1
The Acid Test Ratio measures current assets that are quickly converted to cash compared to current liabilities. Stock is excluded as it
recognises that it is not easily converted into cash. An acceptable figure is considered at 1:1
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