| What is Liquidity? |
|---|
Liquidity is the ability of a company to meet its short‑term obligations (like paying suppliers or wages) without having to sell long‑term assets. Think of it as the amount of cash you have in your wallet to buy a pizza when you’re hungry 🍕. |
| Ratio | Formula | Interpretation |
|---|---|---|
| Current Ratio | \$\displaystyle \frac{\text{Current Assets}}{\text{Current Liabilities}}\$ | Higher than 1 → company can cover its short‑term debts. |
| Quick Ratio (Acid‑Test) | \$\displaystyle \frac{\text{Cash + Marketable Securities + Accounts Receivable}}{\text{Current Liabilities}}\$ | More conservative; excludes inventory. |
| Cash Ratio | \$\displaystyle \frac{\text{Cash + Marketable Securities}}{\text{Current Liabilities}}\$ | Shows pure cash coverage. |
Suppose a company has:
Current Ratio = \$\displaystyle \frac{120,000}{80,000} = 1.5\$
Interpretation: For every £1 of debt, the company has £1.50 in assets to cover it – a healthy liquidity position.
| Tip |
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?? Always check the numerator and denominator – remember “current” means assets or liabilities that can be realised or settled within 12 months. ?? Use the ratio that the question asks for – don’t mix up Current Ratio with Quick Ratio unless specified. ?? Show your working – write the formula and plug in the numbers. ?? Explain the result in plain English – what does a ratio of 1.5 mean for the company’s health? |