3.5.3—Liquidity ratios
- Syllabus
- First assessment 2024
- Objective
- 3.5.3
- Level
- HL
Liquidity ratios test the ability to meet short-term debts
The current ratio = current assets ÷ current liabilities. The acid-test ratio = (current assets − inventory) ÷ current liabilities. The second is stricter because inventory may take time to sell or may realise less than its book value.
A current ratio of 3.07:1 means £3.07 of current assets per £1 of short-term liabilities; if inventory is £8,250 in the same example, the acid test is 1.44:1. Whether that is safe depends on credit terms, stock speed and industry norms.
A stock-heavy retailer can look liquid on the current ratio while struggling to turn stock into cash. Compare both ratios with cash-flow forecasts and the timing of payables rather than treating one threshold as a guarantee.
Liquidity is not profitability and a high ratio can signal idle stock or receivables. Check the quality and timing of current assets, not just the quotient.