Absolute liquid ratio

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-ratio-img1

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.

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

Current liabilities:

  • Accounts payable: $15,000
  • Accrued payable: $5,000
  • Notes payable: $8,000

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

Solution

(1). Current ratio:

Current assets/Current liabilities

= $41,500 / $28,000

= 1.48

or

1.48 : 1

(2). Liquid ratio:

Liquid assets/Current liabilities

= $31,000* / $28,000

= 1.1

or

=1.1  :  1

(3). Absolute liquid ratio:

Absolute liquid assets/Current liabilities

= $23,000** / $28,000

= 0.82

or

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.

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9 Comments on Absolute liquid ratio

  1. Murtaza

    Very good explanation its is very useful for me great job……

  2. Accounting for Management

    Thanks Murtaza.

  3. diwakar muduli

    its most be needed for mgmt student

  4. phillipjekera

    verx good explanation,very helpful

  5. Umer Maz

    thank you AM..
    its very helpful for the preparation of my assignment and viva..

  6. mohiuddin

    The above discussion about ratio analysis is very effective for practical job sector.

  7. Rena

    My hat is off to your astute command over this to-vapbrcio!

  8. TENY

    yes all ratios are very important for analysis .we can easily make dissension for lending .

  9. Kamrul Islam

    Very good explanation….

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