Liquidity Ratio

• What does liquidity refer to in a business context?

  Ability to pay current liabilities when due
• From which financial statement is liquidity ratio information primarily drawn?

  Statement of financial position
• What is another name for the statement of financial position?

  Balance sheet
• What two types of information are compared to assess liquidity?

  Current assets and current liabilities
• What is one common current asset of a business?

  Cash
• What are the three main categories of current assets?

  Cash, inventories, trade debtors
• What are trade debtors?

  Customers who owe money for products
• What are trade creditors?

  Amounts owed to suppliers
• What is an overdraft?

  Money owed to the bank repayable on demand
• How do you calculate the current ratio?

  Current assets divided by current liabilities
• What does a current ratio of more than one indicate?

  Current assets cover current liabilities
• What does a low current ratio suggest?

  Business may struggle to pay liabilities
• What might a very high current ratio indicate?

  Excess capital tied up in assets
• Why is it important to consider industry context when evaluating the current ratio?

  Different industries have varying liquidity needs
• What is the acid test ratio?

  Current ratio excluding inventories from assets
• How does the acid test ratio impact service businesses?

  Minimal impact due to low inventory levels
• Why should trends in the current ratio be monitored over time?

  To identify potential cash flow problems
• What is the most popular liquidity ratio?

  Current ratio
• What should you check regarding your exam board's requirements for liquidity ratios?

  What ratios you are required to know
• What is the purpose of liquidity ratios?

  To assess a business's cash flow management