A ratio used for assessing the liquidity of a company; it is the ratio of the liquid assets (i.e. the current assets less the stock) to the current liabilities. Although there is no rule of thumb, and there are industry differences, a liquid ratio significantly below 1:1 will give rise to concern. The liquid ratio is regarded as an acid test of a company’s solvency and is therefore sometimes called the acid-test ratio.
A company has current assets of £250,000, including stock of £150,000, and liabilities of £120,000. This gives a liquid ratio of:(£250,000 − £150,000)/£120,000 = 0.83,
(£250,000 − £150,000)/£120,000 = 0.83,
i.e. 83% or 0.83:1. This may be interpreted as the company having 83 pence of liquid assets for every £1 of current liabilities. If, for some reason, the company was obliged to repay the current liabilities immediately there would be insufficient liquid assets to allow it to do so. The company might therefore be forced into a hurried sale of stock at a discount to raise finance.
Subjects: Financial Institutions and Services — Accounting.