liquidity ratio

Liquidity

• Liquidity refers to the cash and other current assets businesses have available to quickly pay bills and meet short-term business/financial obligations

• The liquidity of a business can be measured using two ratios, the current ratio and the acid test ratio

Ways to Measure Liquidity

current ratio

acid test

current ratio

• quick way, outcome expessed as ration

• current asset included in calculating ratio

• for business that hold little stock

• current assets / current liabilities

Acid test ratio

The least liquid form of current assets (stock) is deducted so the acid test ratio provides a more realistic measure of the businesses ability to meet short-term debts quickly

• The acid test ratio is a particularly important measure of liquidity for businesses that hold a large amount of stock

• (current assets - stock ) / current liabilities

Ways to improve liquidity

• The best way to improve liquidity is to manage the business better

  • Use cash flow forecasts to identify potential cash flow issues before they arise - and take appropriate action

  • Budget effectively and consider adopting zero budgeting to carefully control spending

  • Set clear financial objectives and look for ways to reduce costs and increase income wherever possible

methods to improve liquidity