7.4. Liquidity ratios
- Syllabus
- 0264–2027–2028
- Topic
- 7.4
- Level
- —
Learning objectives
7.4.1Current ratio• Current ratio = Current assets : current liabilities, or current assets / current liabilities. Answer can be presented as a ratio : 1 or as a number.7.4.2Acid test ratio• Acid test ratio = Current assets - inventory : current liabilities, or (current assets - inventory) / current liabilities. Answer can be presented as a ratio : 1 or as a number.
Calculating the current ratio
The current ratio compares a business's current assets with its current liabilities. It shows how many units of current assets exist for each one unit of current liabilities.
\text{Current ratio}=\frac{\text{current assets}}{\text{current liabilities}}
If current assets are 250,000andcurrentliabilitiesare200,000, the current ratio is 250,000÷200,000 = 1.25. Write the result as 1.25:1 or simply 1.25. The matching currency units cancel.
A result of 0.8:1 means 0.80ofcurrentassetsforeach1 of current liabilities. It is a ratio, not 0.8%, and no ×100 step is used.
Calculating the acid-test ratio
The acid-test ratio compares current assets excluding inventory with current liabilities. Subtract inventory before dividing; this is the step that distinguishes it from the current ratio.
\text{Acid-test ratio}=\frac{\text{current assets}-\text{inventory}}{\text{current liabilities}}
If current assets are 60,000,inventoryis40,000 and current liabilities are 30,000:(60,000 - 40,000)÷30,000 = 0.67. Write 0.67:1 or 0.67; small rounding differences such as 0.66 may follow from recurring decimals.
Do not divide inventory by current liabilities or subtract inventory after dividing. With non-negative inventory, the acid-test ratio cannot exceed the current ratio calculated from the same figures.