Explain Liquid Ratio/ Acid Ratio/ Quick Ratio. What does it indicate?
Liquid Ratio or Acid Test Ratio or Quick Ratio is a liquidity ratio, indicates the backing available to liquid liabilities in the form of liquid assets. A higher liquid ratio indicates that sufficient assets are available with the organization which can be converted in the form of cash almost immediately to pay off those liabilities which are to be paid off almost immediately. Higher the ratio better will be the situation. A standard and ideal liquid ratio is 1:1
Formula to calculate current ratio = Liquid Assets/ Liquid Liabilities
What precautions are required to be taking before drawing a conclusion from Liquid Ratio?
Following precautions are required before drawing a conclusion from liquid ratio:
- Liquid assets exclude the current assets in the form of inventories and prepaid expenses but include the current assets in the form of receivables.
- Non consideration of bank overdraft or cash credit.