Liquidity Ratio

Short term solvency

1. current ratio

     Current Ratio is the relationship between Current Assets and Current Liabilities.

                          Current Ratio = Current Assets/Current Liabilities

     A Current Ratio of 2:1 is considered ideal. That is for every one rupee of Current Liability there must be Current Assets of Rs.2. If the ratio is less than two, it may be difficult for a firm to pay Current Liabilities. If the ratio is more than two, it is an indicator of idle funds.

Current Assets

•                 Cash in hand, Cash at bank, Debtors, Bill Receivable, Prepaid expenses, Money at call and short notice, stock, Sundry supplies, Other amounts receivable within a year
•                 Work-in-progress and Raw materials, short term Investments and securities.

Current Liabilities

•                 Creditors, Bills payable, Bank overdraft, Expenses Outstanding, Interest Due or Payable, Reserve for unbilled expenses, Instalment payable on long-term loans.
•                 Any other amount which is payable in short period
•                 Dividend payable, short-term loans and advance

2. Liquidity ratio or Acid ratio or Quick ratio

     Quick Ratio is also called Acid-Test Ratio because it is the Acid test of a concern’s financial soundness. It is the relationship between Quick Assets and Quick Liabilities. Quick Assets are those Assets which are readily converted into cash. A quick liability refers to ability of a firm to pay its short-term obligations as and when they become due.

formula

• Quick Ratio = Quick Assets/Quick Liabilities
•  Quick Assets = Current Assets – (stock + prepaid expenses)
•  Quick Liabilities = Current Liabilities – Bank Overdraft

Another Formula

•                 Quick ratio = Quick Assets/Current Liabilities

Liquid Assets

•  Bills Receivable, Sundry Debtors, Marketable Securities, Cash in Hand, Cash at Bank
•  Short-term Investments, (Prepaid expenses and stock are not included in the liquid Assets)

Liquid Liabilities

• Bills Payable, Sundry Creditors, Short-term advances, I.T. Payable

3.Absolute
Liquid Ratio(Cash Position Ratio)

     Receivables are also having doubt in their realization. Therefore absolute liquid ratio is found out by the sum of cash and marketable securities, divided by total current liability or total liquid liability.

formula

• Absolute Liquid Ratio = Absolute liquid assets/Current or Quick liability
• The Acceptable norms for the ratio is 0.5:1