Tag: liquidity ratios

Questions Related to liquidity ratios

Liquidity ratio is also known as :-
a. Quick ratio
b. Acid test ratio
c. Working capital ratio
d. Stock turnover ratio

elements of accounts ratio analysis liquidity ratios accounting ratio's accounting ratios

  1. A and B

  2. A and C

  3. B and C

  4. C and D

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Correct Option: A
Explanation:

A liquidity ratio is an indicator of whether a company's current assets will be sufficient to meet the company's obligations when they become due. The liquidity ratios include the current ratio and the acid test or quick ratio. The current ratio and quick ratio are also referred to as solvency ratios.

Consider the following :
i)Basic defensive and interval ratio
ii)Current ratio
iii)Superquick ratio
iv)Quick ratio
Arrange these ratios in sequence to reflect the liquidity in descending order.

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  1. (ii), (iv), (iii) and (i)

  2. (i), (ii), (iv) and (iii)

  3. (iv), (ii), (iii) and (i)

  4. (iii), (iv),(i) and (ii)

Show answer
Correct Option: A
Explanation:

  1. Current ratio = Current assets/Current liabilities
  2. Quick ratio = [Current assets minus inventory]/ Current liabilities
  3. Super quick ratio = [Cash + Marketable securities]/ Current liabilities
  4. Basic defensive and interval ratio = [Cash + Marketable securities + Trade receivables] / Average daily expenditures
 As we move from ratio number $1$ to ratio number $4$ we are calculating the liquidity on more and more conservative basis as it can be seen that as we move from ratios $1$ to $3$ we are considering few and fewer assets  and in the $4$th  ratio we are considering average daily expenditures instead of the whole of current liabilities as this ratio helps us to understand that for how many days can the company survive without having to liquidate its long term assets.

Which of the following is correct?
i.Liquidity ratios measure long term solvency of a concern.
ii.Inventory is a part of current assets.
iii.Rule of thumb for acid test ratio is 1 : 1.
iv.The amount of gross assets is equal to net capital employed.

elements of accounts ratio analysis liquidity ratios accounting ratio's accounting ratios

  1. (i), (ii) and (iv)

  2. (ii), (iii) and (iv)

  3. (i), (ii), (iii) and (iv)

  4. None of the above

Show answer
Correct Option: B
Explanation:
  1. The liquidity ratios measure the ability of a concern to pay off its short term obligations.
  2. Inventory is a part of current assets and not liquid assets.
  3. Rule of thumb for acid test ratio is $1:1$
  4. The amount of gross assets minus the current liabilities is equal to net capital employed. 

The ideal level of liquid ratio is _______.

elements of accounts ratio analysis liquidity ratios accounting ratio's accounting ratios

  1. 1:1

  2. 2:1

  3. 3:1

  4. All of the above

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Correct Option: A
Explanation:

Ideal level of quick ratio or acid test ratio is 1:1. Usually, a high acid-test ratio is an indication that the firm is liquid has ability to meet its current or liquid liabilities in time and on the other hand a low quick ratio represents that the firm's liquidity position is not good.

The appropriate ratio for indicating liquidity crisis is_________.

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  1. Operating ratio

  2. Sales turnover ratio

  3. Current ratio

  4. Acid test ratio

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Correct Option: D
Explanation:

Acid test ratio or Quick ratio = Quick Assets/ Current Liabilities

                                                = [Current Assets minus Inventory]/Current Liabilities
The Quick ratio is a much more conservative measure of short term liquidity than the Current ratio. We reduce the amount of funds held up in inventory  form the current assets ,so that we can get a clear picture of how much fund can we mobilize for payment of dues in case of a cash crunch or a liquidity crisis.

Which of the following is not included in current assets?

elements of accounts ratio analysis liquidity ratios accounting ratio's accounting ratios

  1. Debtors

  2. Opening Stock

  3. Cash at bank

  4. Cash in hand

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Correct Option: B
Explanation:

Current assets is a balance sheet account that represents the value of all assets that can reasonably expected to be converted into cash within one year. current assets include cash and cash equivalents, accounts receivable, marketable securities, prepaid expenses, debtors etc.

 The most precise test of liquidity is ______________.

elements of accounts ratio analysis liquidity ratios accounting ratio's accounting ratios

  1. Quick ratio

  2. Current ratio

  3. Absolute liquid ratio

  4. None of the above

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Correct Option: C
Explanation:

The most precise test of liquidity is "absolute liquid ratio". The ideal absolute liquidity ratio is 1:2. If the ratio is 1:2 or more than this the concern can be considered as liquid. This ratio establishes a relationship between absolute liquid assets and quick liabilities. 

Current ratio is chiefly used to assess the                   .

elements of accounts ratio analysis liquidity ratios accounting ratio's accounting ratios

  1. effective utilization of capital

  2. application of debt

  3. liquidity position

  4. levels of inventory piled up in different forms.

  5. prompt payment of long-term liabilities.

Show answer
Correct Option: C
Explanation:

Current ratio is chiefly used to assess the liquidity position of a company. Let us look at the following example.


Let Current asset = $Rs.100000$ and Current liability = $Rs. 50000$

Current ratio = Current asset/Current liability
                       = $100000/50000$
                       = $2$
So, if at any given point of time if there is a liquidity crisis then the company has twice the amount of  assets to liquidate and pay off the dues. 

The most rigorous test of liquidity is ___________.

elements of accounts ratio analysis liquidity ratios accounting ratio's accounting ratios

  1. Current ratio

  2. Acid ratio test

  3. Absolute measure

  4. Stock turnover ratio

Show answer
Correct Option: C
Explanation:

Absolute measure ratio = absolute cash/current liabilities
Absolute cash = cash + Bank + Marketable Securities

Which of the following transaction change the current ratio?

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  1. Purchase of goods for cash

  2. Plant acquire on account

  3. Sold goods on credit

  4. Debentures converted into equity capital

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Correct Option: B
Explanation:

When plant is acquired on account the fixed asset would increase and there would be increase in the creditors amount, hence the current ratio would decrease. When goods are sold on credit the stock would decrease and the debtors would increase and hence there would be no effect on current ratio.