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Words 812

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Liquidity ratios measure the ability of a company to repay its short-term debts and meet unexpected cash needs.

Current ratio. The current ratio is also called the working capital ratio, as working capital is the difference between current assets and current liabilities. This ratio measures the ability of a company to pay its current obligations using current assets. The current ratio is calculated by dividing current assets by current liabilities.

20X1 20X0 Current assets $38,366 $38,294 Current liabilities 27,945 30,347 Current ratio 1.4 : 1 1.3 : 1

This ratio indicates the company has more current assets than current liabilities. Different industries have different levels of expected liquidity. Whether the ratio is considered adequate coverage depends on the type of business, the components of its current assets, and the ability of the company to generate cash from its receivables and by selling inventory.

Acid-test ratio. The acid-test ratio is also called the quick ratio. Quick assets are defined as cash, marketable (or short-term) securities, and accounts receivable and notes receivable, net of the allowances for doubtful accounts. These assets are considered to be very liquid (easy to obtain cash from the assets) and therefore, available for immediate use to pay obligations. The acid-test ratio is calculated by dividing quick assets by current liabilities.

20X1 20X0 Cash $6,950 $6,330 Accounts receivable, net 18,567 19,230 Quick Assets $25,517 $25,560 Current Liabilities $27,945 $30,347 aAcid-test ratio .9 : 1 .8 : 1

The traditional rule of thumb for this ratio has been 1:1. Anything below this level requires further analysis of receivables to understand how often...

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