## Liquidity / Short-Term Solvency Ratios
Liquidity is the ability of a business to pay its short-term liabilities. Persistent inability to do so hurts credit rating, can lead to commercial bankruptcy, and eventually sickness/dissolution. Short-term lenders and creditors watch these closely.
> Both too little and too much liquidity are bad — excess liquidity means idle funds earning nothing.
The five liquidity measures:
### (a) Current Ratio
$$\text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}}$$
- Generally acceptable benchmark: 2 : 1 (but depends on nature of business).
- Current Assets = Inventories + Sundry Debtors + Cash & Bank + Receivables/Accruals + Loans & Advances + Disposable Investments + any other current assets.
- Current Liabilities = Creditors for goods/services + Short-term loans + Bank overdraft + Cash credit + Outstanding expenses + Provision for taxation + Proposed dividend + Unclaimed dividend + any other current liabilities.
### (b) Quick Ratio (Acid-Test Ratio)
$$\text{Quick Ratio} = \frac{\text{Quick Assets}}{\text{Current Liabilities}}$$
- Quick Assets = Current Assets − Inventories − Prepaid expenses.
- Benchmark: 1 : 1 (satisfactory unless most quick assets are slow-collecting receivables).
- A more conservative test than the current ratio: "If all sales revenue vanished, could I meet current obligations with funds readily on hand?"
### (c) Cash Ratio / Absolute Liquidity Ratio
$$\text{Cash Ratio} = \frac{\text{Cash \& Bank balances} + \text{Marketable Securities (Current Investments)}}{\text{Current Liabilities}}$$
- The most stringent test — only the absolutely liquid resources count.
### (d) Basic Defense Interval / Interval Measure
Number of days the firm can cover cash expenses if all revenue suddenly stopped, without extra financing.
$$= \frac{\text{Cash \& Bank} + \text{Net Receivables} + \text{Marketable Securities}}{\text{Daily Operating Expenses}}$$
or equivalently $\dfrac{\text{CA − Prepaid expenses − Inventories}}{\text{Daily Operating Expenses}}$
where $$\text{Daily Operating Expenses} = \frac{\text{COGS} + \text{Selling, Admin \& General Exp} - \text{Depreciation \& Non-cash Exp}}{\text{No. of days in a year}}$$
### (e) Net Working Capital
More a measure of cash flow than a ratio; bankers track it over time and often tie loans to a minimum NWC.
$$\text{NWC} = \text{Current Assets} - \text{Current Liabilities (excl. short-term bank borrowing)}$$