Liquidity

• Liquidity 


  The ability of a business to turn its assets into cash to pay it's current liabilities
• Business owner and investors can use liquidity as a measure of how healthy the business is, it doesn't have too may debts and it can easily pay its bills
• Ways to measure liquidity

  1. Current ratio
  2. Acid test ratio
• • Current assets are assets that can be converted into cash relatively easily. E.g: cash, inventory
  • Non current assets are long term or fixed assets that are used within a business and contribute to it's actual operations E.g: land, plant property and equipment (PP&E)
• Acid test ratio - is a harsher test of liquidity because you can not guarantee to sell all of the stock. Stock can also spoil become obsolete or just go out of fashion.
• Acid test ratio of less than 1:1 means the current assets do not cover its current liabilities.

  However some retailers with strong cash flow and fast moving stocks may have an acid test of 0.4:1 and be fine, it depends on the industry.