Liquidity ratio indicates that the firm has sufficient liquid resources to meet its short-term liabilities.
It measures the ability of the firm to meet its short-term obligations, i.e., capacity of the firm to pay its current liabilities as and when they fall due.
Also known as “short-term solvency ratio” or “working-capital ratio”. Thus these ratios reflect the short-term financial solvency of a firm.
The various ratios that explains about the liquidity of the firm are
1. CURRENT RATIO
The current ratio measures the short-term solvency of the firm. It establishes the relationship between current assets and current liabilities.
It is calculated by dividing current assets by current liabilities. An ideal ratio would be 2:1 which provides margin of safety to the creditors and financial stability.
Current Ratio = Current Assets
Current assets cover
Current liabilities include
2. ACID TEST RATIO / QUICK RATIO/LIQUID RATIO
It has been an important indicator of the firm’s liquidity position and is used as a complementary ratio to the current ratio.
It establishes the relationship between quick assets and current liabilities. It is calculated by dividing quick assets by the current liabilities.
Acid Test Ratio = Liquid Assets
Liquid ratio is the true test of business solvency. The ideal ratio is 1:1 which indicates sound financial position.
It shows the relationship between absolute liquid or super quick current assets and liabilities.
Absolute liquid assets include cash, bank balances, and marketable securities.
Absolute liquid ratio = Absolute liquid assets