In addition to computing current and quick ratio, some analysts also compute absolute liquid ratio to test the liquidity of the business. Absolute liquid ratio is computed by dividing the absolute liquid assets by current liabilities.

Formula:

The formula to compute this ratio is given below:

Absolute liquid assets are equal to liquid assets minus accounts receivables (including bills receivables). Some examples of absolute liquid assets are cash, bank balance and marketable securities etc.

Example

Following are the current assets and current liabilities of a trading company:

Current assets:
Cash and Bank $5,000
Marketable securities $18,000
Accounts receivables, net $8,000
Inventories $10,000
Prepaid expenses $500
———-
41,500
———-
Current liabilities:
Accounts payable $15,000
Accrued payable $5,000
Notes payable $8,000
———-
$28,000
———-

Required: Compute current ratio, quick ratio and absolute liquid ratio from the above data.

Solution

(1)

current-ratio-formula

$41,500 / $28,000

= 1.48

or

1.48 : 1

(2)

quick-ratio-formula

= $31,000* / $28,000

= 1.1

or

=1.1  :  1

(3)

$23,000** / $28,000

= 0.82

or

0.82 : 1

*Liquid ratio: $5,000 + $18,000 + $8,000 = $31,000
**Absolute liquid ratio: $5,000 + $18,000  = $23,000

The reason of computing absolute liquid ratio is to eliminate accounts receivables from the list of liquid assets because there may be some doubt about their quick collection. This ratio is useful only when used in conjunction with current ratio and quick ratio. An absolute liquid ratio of 0.5:1 is considered ideal for most of the companies.