GCSE-ready- Home
- Lessons
- GCSE & IGCSE Business
- Liquidity ratios
Liquidity ratios
🎬 The doodle video for this lesson is coming soon. Subscribe on YouTube to see it first.
A business can be profitable and still fail if it cannot pay its short-term debts. Liquidity ratios check this.
What liquidity means
Liquidity is the ability to pay short-term debts (current liabilities) when they are due.
Cash is the most liquid asset. Inventory is the least liquid current asset, because it must be sold first.
Cash is the most liquid asset. Inventory is the least liquid current asset, because it must be sold first.
The ratios
Current ratio = current assets ÷ current liabilities
Acid test ratio = (current assets − inventory) ÷ current liabilities
The acid test is stricter because it leaves out inventory.
They are often written as a ratio, such as 1.5 : 1.
Acid test ratio = (current assets − inventory) ÷ current liabilities
The acid test is stricter because it leaves out inventory.
They are often written as a ratio, such as 1.5 : 1.
Interpreting
A current ratio below 1 means current assets cannot cover current liabilities: a warning sign. A ratio of about 1.5 to 2 is often seen as comfortable.
An acid test ratio of about 1 is often seen as comfortable.
Too high can mean money is tied up in idle cash or stock. Compare with previous years and similar businesses.
An acid test ratio of about 1 is often seen as comfortable.
Too high can mean money is tied up in idle cash or stock. Compare with previous years and similar businesses.
Current assets £60 000 (including inventory £20 000). Current liabilities £40 000. Find both ratios.
- Current ratio = 60 000 ÷ 40 000 = 1.5
- Acid test = (60 000 − 20 000) ÷ 40 000 = 1
Answer: 1.5 : 1 and 1 : 1
Liquidity is the ability to pay short-term debts. Current ratio = current assets ÷ current liabilities. Acid test = (current assets − inventory) ÷ current liabilities. Low ratios warn of cash problems.
Check you have got it
Answer 7 quick questions with instant marking. If you get one wrong, GCSE-ready shows you why and gives you another go. It is free, and you do not need an account.