Liquidity refers to the ability of a firm to meet its short term obligations, usually 1 year.
The following two ratios are considered as Liquidity ratios
Current Ratio
Acid Test Ratio
Current Ratio = Current Assets / Current liabilities
Acid Test Ratio = Quick Assets / Current Liabilities
Acid Test ratio is also known as Quick ratio since it considers only the quick assets which are more liquid. Inventory is not considered as part of quick assets since it’s can’t be converted quickly into cash.
The two ratios show the healthiness of a company meeting its short term obligations. Usually 1:1 current ratio is considered as a good ratio. 1:1 indicates that assets and liabilities are in acceptable levels. High numerator value means inefficient use of assets and high denominator value means inability of the company to meet its short term liabilities.
Sathish Emmadi
Sathish Emmadi is a co-founder & editor at Lastbull.com. He is presently working in IT for one of the world’s top mutual fund companies. Handled multiple projects in BFSI (Banking,Financial Services and Insurance) domain. An Engineering Graduate from NITW.
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- Assets and Types of Assets – Financial Accounting
- What are Liabilities in balance sheet and Types of Liabilities
- What is CRR (Cash Reserve Ratio) ?
- What is SLR (Statutory Liquidity Ratio) ?
- Preferred Habitat Theory and Liquidity preference Theory
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