Liquid Ratio or Acid Test Ratio or Quick Ratio – Definition, Explanation and Use:
Current ratio (which takes all current assets into account) may give an over optimistic view of the company’s short-term financial strength (liquidity). The liquid ratio (sometimes referred as acid test ratio or quick ratio) offers a more rigorous test of liquidity. Inventory traditionally, the least liquid asset is excluded for the calculation of liquid ratio. Liquid assets are those current assets which are easily convertible into cash as and when business desires.
Click on Analysis of Financial Statement of a Business to read the solved example of liquid ratio.
Analysis and Interpretation – Ideal Liquid Ratio:
The liquid ratio is always less than current ratio because the former excludes inventory from the calculation which is not convertible into cash as short notice. Some analysis are of the view that ideal acid test ratio should be in between to 0.7:1 to 1:1; however this again varies from industry to industry meaning therefore that there is no ideal liquid ratio. Moreover some of the current liabilities shown in a balance sheet might not be payable immediately. For instance, the tax and dividends liability are not payable immediately after the end of accounting year.