In part two ratio analysis, we discuss the liquidity ratio. The liquidity ratio consists of the current rate, acid test the ratio and cash ratio.
1) Current ratio- The current ratio is the most widely used liquidity ratio to measure how a business can survive in the future; if a company is unable to pay its Debt, it can dilute its assets.
It measures how easily a business can pay short-term liabilities with short-term assets Current ratio is the general indication of safety for a business. A high Current ratio is better.
Interpreation-Higher Current ratio increase means more able to pay upcoming short-term debit. A high current ratio means a more profitable business.
2 ) Acid-test ratio- Acid-test ratio second liquid ratio.it’s more flexible than the Current ratio in that more liquid assets are used to cover the Current liabilities such as cash and cash equivalents, short-term investment, and short-term receivables.
formula:- cash& cash equivalent + short term investment +Current recivabes/Current liabilities.
Interpretation- A higher Acid test ratio is better
3) Cash ratio- The cash ratio is one of the strictest ratios of the liquidity ratio group. It measures the company’s ability to cover its short-term obligations by ash only.
Cash ratio=Cash& cash equivalent + short-term investment /Current liabilities
Interpretation- Not a definitive rule, but a high cash ratio is better for a company.
This is an explanation of liquidity ratios.