What are liquidity ratios

Updated: Feb 22

There are two (2) liquidity ratios. Current ratio and Acid test ratio.

Current Ratio

Current ratio measures the value of current assets over current liabilities. As current assets are the value of items that can be made easily available for a business to utilize, the current ratio can measure how many times a business is able to repay all their current liabilities with the current asset it owns (liquidity). As such, the higher the ratio, the more able the business is able to repay its short-term debt (current liabilities).

Acid Test Ratio

The acid test ratio is similar to the current ratio, but it excludes inventories as part of current assets to determine the liquidity of the business. As inventories may still take some time to be disposed off to convert into cash, this ratio can determine the maximum amount (liquidity) the business have that can be converted into cash immediately to repay debts. Higher ratio indicates better ability of the firm to repay short-term debts without selling off inventory.