liquidty

• Liquidity

  How easily an asset can be turned into cash and used to buy things
• Liquidity ratios show how much money is available to pay the bills
• Cash

  • Very liquid
• Non-current assets (e.g. factories)


  • Not liquid
• Inventory and receivables

  • In between cash and non-current assets in terms of liquidity
• A business that doesn't have enough current assets to pay its liabilities when they are due is insolvent
• Improving liquidity

  1. Decreasing stock levels

  2. Speeding up collection of debts

  3. Slowing down payments to creditors
• Current ratio

  Compares current assets to current liabilities
• Ideal current ratio

  • 1.5 to 2
• Current ratio below 1.5


  • Suggests liquidity problem and may struggle to meet current liabilities
• Current ratio much higher than 2


  • Suggests more current assets than needed, money could be reinvested to make more profit
• Acid test ratio


  Measures liquidity by excluding inventory from current assets
• Ideal acid test ratio

  • Higher than 1
• Businesses with high stock turnover


  • May have very low acid test ratio and still survive
• Working capital

  Difference between current assets and current liabilities
• Positive working capital means a business can meet its short-term obligations
• Negative working capital means a business may struggle to meet its short-term obligations
• Current ratio= current assets/ current liabilites
• Acid test ratio = (current assets - inventory)/ current liabilities