2. LIQUIDITY RATIOS
Assets → cash
• Quickly and no loss of value
• reveals the level of liquidity
• 2 types- Current Ratio/ Acid Test Ratio
• Comes from the Balance Sheet
3. KEY TERMS
• Liquid assets (Current Assets)- Cash,
Debtors, Stock
• Short- term liabilities
• Working Capital
• Opportunity Cost
• Liquidity crisis
4. CURRENT RATIO
• Liquid assets and short-term liabilities
• Working capital
Value/ Importance
• Using liquid assets to cover short-term
liabilities
• Desirable ratio of 1.5-2.0 to 1
• Safety margin
• Shows the liquidity position of the firm
• Important for trade creditors
6. EXAMPLE: CURRENT RATIO
Company A
Current Assets: 500,000
Stock: 200,000 Cash: 100,000 Debtors:
200,000
Current Liabilities: 350,000
500,000
350,000
Current Ratio- 1.43:1
Meaning: For every $1 of current liabilities, the firm has $1.43 of
current assets
7. ACID TEST RATIO
Current assets and short- term liabilities (working
capital)- stock
Value/ Importance
More meaningful than Current Ratio
• At least 1:1
• Important for potential investors and
short-term lenders (exposes the level of risk)
• Can determine 2 things:
– experiencing a liquidity crisis
– holding too much current assets
9. EXAMPLE: ACID TEST RATIO
Company A
Current Assets: 500,000
Stock: 200,000 Cash: 100,000 Debtors:
200,000
Current Liabilities: 350,000
(500,000- 200,000)= 300,000
_______________
350,000
Acid Test Ratio- 1:1.12
Meaning: For every $1.12 of current liabilities, the firm has $1 of
(current assets- stocks) = Possible that the firm is experiencing
a LIQUIDITY CRISIS!!