Liquidity Ratio or Acid Test Ratio

This ratio determines the ratio of liquid assets to that of current liabilities.  As such it enables you to determine the ability of a business to pay its short term debts as and when they become due for payment. Liquid assets normally comprise such items as  cash at bank, sundry debtors, bills receivable and market securities etc.  i.e. Current Assets – ( Inventory Stock and prepayments).

Formula =  Liquid Ratio = Liquid Assets / Current liabilities

Hence Liquid Assets :  200 + 1600 = 1800

Current Liabilities =  300 + 600 + 200+ 900 = 2000

Liquid Ratio = 1800/2000 = 0.9 : 1

Absolute Liquid Ratio

This considers cash or near cash items and is a ratio of absolute assets to that of current liabilities. Absolute liquid assets are such items as  cash, bank and market securities.  The ratio has particular significance when used in consortium with both current and liquid ratios. The ratio of 0.5:1 is considered as an acceptable norm

Formula : Absolute liquid ratio = Absolute liquid Assets / Current Assets

Absolute liquid assets = 500

Current Assets =1100

Absolute Liquid Ratio = 500/1100 = 0.45:1

The Liquidity or Acid Test ratio is one of the most widely used business financial benchmarks as it tells you whether you can pay your short term debts.  (Accounting for Management, 2011)