Liquidity Ratios - Current Ratio and Quick Ratio (Acid Test Ratio)
The Organic Chemistry Tutor・5 minutes read
Liquidity ratios like the current ratio and quick ratio evaluate a company's ability to meet short-term financial obligations, with ratios above 1 being positive and below 1 being negative. For example, Company A's current ratio of 2.0 shows financial stability, while Company B's ratio of 0.5 indicates financial risk.
Insights
- Liquidity ratios like the current ratio and quick ratio gauge a company's ability to pay off short-term debts within a year, with a ratio above 1 showing assets exceed liabilities, and below 1 indicating the opposite.
- The quick ratio focuses on liquid assets like cash and equivalents, providing a more stringent assessment of a company's financial health, ensuring there are enough liquid assets to cover immediate obligations.
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Recent questions
What do liquidity ratios measure?
Liquidity ratios assess a company's ability to meet short-term financial obligations within a year.
How is the current ratio calculated?
The current ratio compares current assets to current liabilities, with a ratio above 1 indicating assets exceed liabilities.
What does a current ratio of 2.0 signify?
A current ratio of 2.0 shows assets exceeding liabilities, a positive sign for financial stability.
What assets are considered in the quick ratio?
The quick ratio considers only liquid assets like cash, equivalents, accounts receivable, and marketable securities.
How is the quick ratio beneficial for analysis?
Calculating the quick ratio for a company reveals if there are sufficient liquid assets to cover current liabilities, indicating financial health.
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Summary
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Assessing Liquidity: Current and Quick Ratios
- Liquidity ratios, such as the current ratio and quick ratio, assess a company's ability to meet short-term financial obligations within a year. The current ratio compares current assets to current liabilities, with a ratio above 1 indicating assets exceed liabilities, while a ratio below 1 signifies the opposite.
- Using examples, the current ratio for Company A (2.0) shows assets exceeding liabilities, a positive sign, while Company B (0.5) indicates liabilities surpassing assets, a negative scenario. Calculating the current ratio for Company XYZ (1.67) demonstrates assets exceeding liabilities, ensuring financial stability.
- The quick ratio, another liquidity measure, considers only liquid assets like cash, equivalents, accounts receivable, and marketable securities. Calculating the quick ratio for Company ABC (2.5) reveals sufficient liquid assets to cover current liabilities, indicating financial health.
