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.
The formula to compute this ratio is given below:
Absolute liquid assets are equal to liquid assets minus accounts receivable and bills receivable. These assets usually include cash, cash equivalents, bank balances and marketable securities etc.
Following are the current assets and current liabilities of a trading company:
- Cash and Bank: $5,000
- Marketable securities: $18,000
- Accounts receivables, net: $8,000
- Inventories: $10,000
- Prepaid expenses: $500
Required: Compute current ratio, quick ratio and absolute liquid ratio from the above data.
(1). Current ratio:
Current assets/Current liabilities
= $41,500 / $28,000
1.48 : 1
(2). Liquid ratio:
Liquid assets/Current liabilities
= $31,000* / $28,000
=1.1 : 1
(3). Absolute liquid ratio:
Absolute liquid assets/Current liabilities
= $23,000** / $28,000
0.82 : 1
*Liquid assets: $5,000 + $18,000 + $8,000 = $31,000
**Absolute liquid assets: $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.