Measuring Liquidity (AQA A Level Business): Revision Note

Packer Sports Ltd has current assets of £15,545, current liabilities of £5,060 and an inventory figure of £8,250.

Calculate Packer Sports Ltd’s current ratio.

Current ratio

   $$\begin{gathered} =\frac{\pounds 15,545}{\pounds 5,060} \\ =3.07:1 \end{gathered}$$

• In this example, Packer Sports Ltd has £3.07 of current assets to cover each £1 of short-term debt

Packer Sports Ltd has current assets of £15,545, current liabilities of £5,060 and an inventory figure of £8,250.

Calculate Packer Sports Ltd’s acid test ratio.

Calculate liquid assets

$$\begin{gathered} =\pounds 15,545-\pounds 8,250 \\ =\pounds 7,295 \end{gathered}$$

Acid test

$$\begin{gathered} =\frac{\pounds 7,295}{\pounds 5,060} \\ =1.44:1 \end{gathered}$$

• In this example, Packer Sports Ltd has £1.44 of its most liquid current assets to cover each £1 of short-term debt.

Thornbury Electronics

Thornbury Electronics' finance director has gathered the following data from the company's balance sheet.

Explain why Thornbury Electronics may struggle to pay its current liabilities.

Explanation

• The large gap between the two ratios —0.82 — tells us that Thornbury holds a significant amount of its current assets in the form of stock

• If that stock is slow-moving or difficult to sell quickly, the business's true liquidity position is weaker than the current ratio alone suggests

• With only £0.91 to pay each £1 of debt, the business may struggle to cover its current liabilities

When interpreting liquidity ratios, always consider the type of business and the time of year. A ratio below the benchmark is not automatically a crisis - a seasonal business may routinely dip below 1:1 at certain points in the year. Equally, a ratio well above 2:1 is not always ideal - it may indicate idle cash that could be invested more productively. Context is everything