Liquidity (Cambridge (CIE) IGCSE Business): Revision Note

Liquidity refers to the cash and other current assets businesses have available to quickly pay bills and meet short-term financial obligations

A business that cannot pay its debts is considered insolvent

• If a business cannot pay its suppliers, raw materials or components may not be delivered, and production may be delayed

• If it cannot repay an overdraft, banking facilities may be withdrawn, and its credit rating will suffer

• Creditors may force it to stop trading and sell its assets so that the debts owed to them are repaid

The liquidity of a business can be measured using two ratios

• Current ratio

• Acid test ratio

The current ratio indicates how many £s (or other currency units) of current assets are available to cover each £1 (or other currency unit) of short-term debt

• Its is a quick way to measure liquidity

  • The outcome is expressed as a ratio

  • All types of current asset are included in calculating this ratio

  • The result

It is calculated using the formula

The Acid Test Ratio (also called the Quick Ratio) is a measure of a business’s liquidity – how easily it can pay its short-term debts without relying on selling inventory (stock)

• It is expressed as a ratio

• It is also known as the liquid capital ratio

• The least liquid form of current assets (inventory) is deducted so the acid test ratio provides a more realistic measure of the bbusiness'sability to meet short-term debts quickly

  • It often takes time to sell inventory so it is excluded

The acid test is calculated using the formula