CAT / FIA FMA Syllabus F. Performance Measurement - Measuring Liquidity - Notes ^{3 / 15}

There are two main measures of liquidity:

1. the current ratio

2. the quick (or acid test) ratio

Current Ratio

The current ratio is expressed as:

• Current assets : Current Liabilities

  If current assets exceed current liabilities then the ratio will be greater than 1 and indicates that a business has sufficient current assets to cover demands from creditors.

Quick (Acid Test) Ratio

This is expressed as:

• Current assets – Stocks : Current Liabilities

  If this ratio is 1:1 or more, then clearly the company is unlikely to have liquidity problems. 

  If the ratio is less than 1:1 we would need to analyse the structure of current liabilities, to those falling due immediately and those due at a later date.

Illustration

Inventory $10,000
Receivables $15,000
Payables $12,000

What is the current ratio?

25,000/12,000 = 2.08 times

What is the quick ratio?

15,000/12,000 = 1.25 times