capability of being converted into cash with ease. Liquidity ratios help to assess the ability of a business concern to meet its short term financial obligations. Short term assets (current assets) are more liquid as compared to long term assets (fixed assets). Liquidity ratios are also called as short term solvency ratios.
Liquidity ratios include: (i) Current ratio and (ii) Quick ratio. (i) Current ratio Current ratio gives the proportion of current assets to current liabilities of a business concern. It is computed by dividing current assets by current liabilities. Current ratio indicates the ability of an entity to meet its current liabilities as and when they are due for payment.
It is calculated as follows: Current assets Current ratio =Current liabilities Current assets Current liabilities Current assets are those assets that are either in the form of cash or cash equivalents or can be converted into cash or cash equivalents in a short time, that is, within a year or within the period of an operating cycle. Current liabilities are those liabilities which are repayable in short time, that is, within a year or within the period of an operating cycle. Current assets include Current liabilities include (i) Current investments (ii) Inventories (stock) (iii) Trade receivables (Bills receivable and sundry debtors less provision for doubtful debts) (iv) Cash and cash equivalents (Cash in hand, cash at bank, etc.) (v) Short-term loans and advances given (vi) Other current assets (Prepaid expenses, accrued income, etc) (i) Short-term borrowings (ii) Trade payables (Bills payable and sundry creditors) (iii) Other current liabilities (Expenses payable, income received in advance, etc.) (iv) Short-term provisions