Liquidity ratio full with exam

Liquidity Ratios: Liquidity ratios measure the firm’s ability to fulfil its short-term financial obligations.
(i) Current ratio/Working capital ratio This ratio establishes relationship between current assets and current liabilities and is used to assess the short-term financial position of the business concern. Current ratio of 2:1 is considered to be ideal.

Items Included in Current Assets
(a) Current investments
(b) Inventories (Excluding loose tools, stores and spares)
(c) Trade receivables (bills receivable and sundry debtors less provision for doubtful debts)
(d) Cash and cash equivalents (cash in hand, cash at bank, cheques/drafts in hand)
(e) Short-term loans and advances
(f) Other current assets (prepaid expenses, interest receivable, etc.)
Items Included in Current Liabilities
(a) Short-term borrowings
(b) Trade payables (bills payable and sundry creditors)
(c) Other current liabilities (current maturities of long-term debts, interest, accrued but not due on borrowings, interest accrued and due on borrowings, outstanding expenses, unclaimed dividend, calls-in-advance, etc)
(d) Short-term provisions
(ii) Liquid ratio/Quick ratio/Acid test ratio This ratio establishes relationship between liquid assets and current liabilities and is used to measure the firm’s ability to pay the claims of creditors immediately. This ratio is a better indicator of liquidity and 1 : 1 is considered to be ideal.

Items Included in Liquid/Quick Assets
(i) Current investments.
(ii) Trade receivables (bill receivables, debtors less provisions for doubtful debts).
(iii) Cash and cash equivalents.
(iv) Short-term loans and advances.
(v) Other current assets except prepaid expenses.
Items excluded in liquid assets are inventories, prepaid expenses.
Items Included in Current Liabilities
(i) Short-term borrowings.
(ii) Trade payables (bills payable and sundry creditors).
(iii) Other short-term liabilities.
(iv) Short-term provisions.