Liquidity Ratios.

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Current Ratio

Current Assets
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Current Liabilities

The current ratio considers how well a business can cover the current liabilities with its current assets. It is a common belief that the ideal for this ratio is between 1.5 and 2 : 1 so that a business may comfortably cover its current liabilities should they fall due.

However this ideal should be considered in the context of the company: the nature of the assets in question, the company’s ability to borrow further to meet liabilities and the stability of its cash flows.

For example, a business in the service industry would have little or no inventory and therefore could have a current ratio of less than 1. This does not necessarily mean that it has liquidity problems so it is better to compare the result to previous years or industry averages.

Quick Ratio

Current Assets – Inventories
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Current Liabilities

One of the problems with the current assets ratio is that the assets counted include inventories which may or may not be quickly sellable (or which may only be sellable quickly at a lower price).

The ideal ratio is thought to be 1:1, but as with the current ratio, this will vary depending on the industry in which the business operates.

The quick ratio is also known as the acid test ratio. This name is used because it is the most demanding of the commonly used tests of short term financial stability.
When assessing both the current and the quick ratios, remember that both of these ratios can be too high. This would mean too much cash is being tied up in current assets as opposed to new more profitable investments.

It is important to look at the information provided within the question to consider whether or not the company has an overdraft at year-end.  The overdraft is an additional factor indicating potential liquidity problems and this form of finance is both expensive (higher rates of interest) and risky (repayable on demand)

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