Accounting & auditingLesson 3 of 6 in the course Measures of Financial Health

Current, Quick, and Cash Ratios for Short-Term Liquidity

5 flashcards · 5 quiz questions · 5 match pairs · 4 fill-in sentences · English

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Summary

Liquidity ratios help assess whether a business can meet obligations due in the near term. This lesson introduces liquidity, compares the relative liquidity of common assets, and explains how to calculate and interpret the current ratio.

Liquidity is a business’s ability to manage current assets or convert them into cash to meet short-term cash needs. Cash is immediately available. Other assets may need to be collected or sold before they can be used to pay obligations.

All flashcards

Liquidity
A business’s ability to manage current assets or convert assets into cash to meet short-term cash needs.
Quick ratio (acid-test ratio)
Cash, short-term investments, and accounts receivable divided by current liabilities.
Current ratio
Current assets divided by current liabilities.
Cash ratio
Cash and cash equivalents divided by current liabilities.
Why should liquidity ratios be compared with trends and industry averages?
Context helps assess asset quality, timing, and whether a ratio is typical for the business.

Quiz questions

  1. Which formula calculates the quick ratio?Answer: Cash, short-term investments, and accounts receivable divided by current liabilities.
  2. Which assets are excluded from the quick ratio as presented here?Answer: Inventory and prepaid expenses.
  3. What does a cash ratio of 1.1 indicate?Answer: Cash and cash equivalents exceed current liabilities.
  4. Which liquidity ratio uses the narrowest asset base and is therefore the most conservative?Answer: The cash ratio.
  5. Why is a cash ratio below 1.0 not automatically evidence that a business is failing?Answer: Many businesses operate successfully without enough cash to pay every current liability at once.

Based on Principles of Finance by Julie Dahlquist, Rainford Knight (OpenStax), licensed CC BY 4.0. Adapted into a summary, flashcards and quizzes.

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