The quick assets include only cash and cash equivalents, short-term investments, and account receivables. Examples of Liquidity Ratios Typically, the following financial ratios are considered to be liquidity ratios: Current ratio Quick ratio or acid test ratio Current assets are liquid assets that can be converted to cash within one year such as cash, cash equivalent, accounts receivable, short-term deposits and marketable securities. The formula to calculate the acid test ratio is: Acid Test Ratio = (Cash and Cash Equivalents + Current Receivables + Short-Term Investments) / Current Liabilities. Common liquidity ratios are the current ratio, the quick ratio, and the cash ratio. There are different liquidity ratios, so there are also different formulas. A ratio of less than 1 indicates a negative working capital situation and the possibility of a liquidity crisis. Liquidity is a measure of how quickly a firm is able to convert its assets into cash. The formula for calculating the current ratio is as follows: Current Ratio = Current Assets / Current Liabilities. This is the standard case for a healthy company. There is no single liquidity ratio. Buy Now & Save. This ratio is used by creditors and lenders to know how much time to delay the credit. It is defined as the ratio between quickly available or liquid assets and current liabilities.Quick assets are current assets that can presumably be quickly . We then measure it using several ratios. Or, if the organization has $2000 in cash and $1000 in accounts payable, the quick ratio would be 2:1. A liquidity ratio is used to determine a company's ability to pay its short-term debt obligations. CFA and Chartered Financial Analyst are registered trademarks owned by CFA Institute. What is the price elasticity of demand for a price change from $\$ 0$ to $\$ 20$ . It excludes inventory, account receivables and any other current assets. We use analytics cookies to ensure you get the best experience on our website. 1. Liquidity ratios further represent whether a company has enough cash to pay off liabilities or whether it must use some of its assets, such as inventory, accounts receivable or trading securities, to turn into cash. Use the mid-point method in your calculations. For example, if an organization has $250 in cash and $250 in accounts receivable, the quick ratio would be 1:1. A liquidity ratio that is greater than 1 reassures banks that it's safe to provide a company with a loan. Liquidity ratios are often confused with solvency ratios. This site uses cookies. If he leaves the money in the account without making any more deposits, how much will he have on his $65th$ birthday, assuming the account continues to earn the same rate of interest? If you need income tax advice please contact an accountant in your area. To see our product designed specifically for your country, please visit the United States site. Since the inventory values vary across industries, its a good idea to find an industry average and then compare acid test ratios against for the business concerned against that average. Quick ratio = Liquid Assets or Quick Assets/ Current Liabilities. b) Long term solvency ratio . Liquidity ratios provide information about the liquid situation and stability of a company. Cash ratio = = (50,000 + 20,000) / 80,000 x 100 = 88%. 22. Dividend payout ratio is a: a) Turnover ratio. A ratio of 1:1 indicates that current assets are equal to current liabilities and that the business is just able to cover all of its short-term obligations. In other words, a liquidity ratio shows whether a company has enough current assets to cover its liabilities. The three main liquidity ratios are the current ratio, quick ratio, and cash ratio. As seen above, the liquid Ratio of Y Ltd is 1:1, which is an idle ratio. Current ratio = current assets/current liabilities read more is a financial measure of an organization's potential for meeting its current liabilities Current Liabilities Current Liabilities are the payables which . It indicates that the company is in good financial health and is less likely to face financial hardships. Accounts receivable and inventories are also included in liquidity under certain circumstances. It indicates how well a company is able to repay its current liabilities with its current assets. Liquidity Ratio Liquidity ratio expresses a company's ability to repay short-term creditors out of its total cash. In essence, it measures if a business is liquid, that is if it can quickly exchange its tangible assets for cash. A liquidity ratio of more than one is considered ideal and . Current Assets/Current Liabilities = Current ratio. These ratios assess the overall health of a business based on its near-term ability to keep up with debt. 23. One problem with this ratio is that it assumes that the inventory and account receivables are liquid. The current ratio is calculated as Current Assets/Current Liabilities. 80,000 - 25,000 - 5,000 = Rs. Inventory Turnover and Days of Inventory on Hand (DOH), Receivables Turnover and Days of Sales Outstanding (DSO), Payables Turnover and Number of Days of Payables, Fixed Asset and Total Asset Turnover Ratio, Liquidity Ratios (Current Ratio, Quick Ratio, and Others), R Programming - Data Science for Finance Bundle, Options Trading - Excel Spreadsheets Bundle, Value at Risk - Excel Spreadsheets Bundle. Marketable securities include, for example, securities or bonds that can be sold quickly. You can decline analytics cookies and navigate our website, however cookies must be consented to and enabled prior to using the FreshBooks platform. Cash Ratio A liquidity ratio is a financial metric that measures your company's ability to pay off your existing debts. Overall Liquidity Analysis Liquidity ratio is a measure of the ability of the companies to transform immediately of its assets into any other asset and pay their short-term obligation due on time. Purposive sampling technique is used in order to . It also helps to perceive the short-term financial position. The optimum value of the Absolute Liquidity Ratio for a company is 1:2. Liquidity ratios are financial ratios which measure a company's ability to pay off its short-term financial obligations i.e. However, when evaluating a company's liquidity, the current ratio alone doesn't determine whether it's a good investment or not. There are several ratios available for analysis, all of which compare the liquid assets to the short-term liabilities. This optimum ratio indicates the sufficiency of the 50% worth absolute liquid assets of a company to pay the 100% of its worth current liabilities in time. current liabilities using its current assets. The company's short-term liabilities are presented in current liabilities. If the cash ratio is less than 1, theres not enough cash on hand to pay off short-term debt. b) liquidity ratio . Current ratio Quick ratio / Acid test ratio Cash ratio Current ratio The current ratio measures the ability of a company's available current assets to offset short-term liabilities if the current assets are liquidated. You can work out the current ratio using the following liquidity ratio formula: Current Ratio = Current Assets / Current Liabilities Quick ratio - Also known as the acid-test ratio, the quick ratio looks at whether you're able to pay off your liabilities with quick assets, which are assets that you can convert to cash within the space of 90 days. As such, it is the most conservative of all the liquidity ratios, and so is useful in situations where current liabilities are coming due for payment in the very short term. (A) A man deposits $\$ 2,000$ in an IRA on his $21st$ birthday and on each subsequent birthday up to, and including, his $29 th$ (nine deposits in all). Why may an acid test be more useful than current ratio? How to Calculate Overhead Costs in 5 Steps. #1 - Current Ratio. If the cash ratio is very high, it means that a lot of cash is lying around unused and cannot be used for investments and growth. Liquidity ratio The liquidity ratio defines one's ability to pay off debt as and when it becomes due. The current ratio in the example is 250%. The three types of liquidity ratios are the current ratio, quick ratio and cash ratio. A low ratio is a cause of concern and the analyst need to look into whether the company is expecting stronger cash inflows. This takes an even closer look at the liquidity situation, as only the most liquid funds are compared to the current liabilities. Liquidity ratios, according to financial-accounting.us, are commonly split into two types. Cash ratio, also called cash asset ratio, is the ratio of cash and cash equivalent assets to its total liabilities. The ratio indicates the extent to which readily available funds can pay off current liabilities. This ratio is considered a superior measure to the current ratio. The liquidity ratio is represented by Current ratio, profitability ratio is represented in Return on Investement (ROI), and leverage ratio is represented by Debt to Equity ratio. A company has the following values in its balance sheet: We can now calculate the different liquidity ratios using the formulas from the previous section: Current ratio = (50,000 + 20,000 + 100,000 + 30,000) / 80,000 x 100 = 250% Quick ratio = (50,000 + 20,000 + 100,000) / 80,000 x 100 = 213% End of Year Sale Get 70% Off for 3 Months. Liquidity ratio formulas and examples. If the difference between the acid test ratio and the current ratio is large, it means the business is currently relying too much on inventory. It is very important for a business owner to have complete knowledge of this concept, else the business may sink . Liquidity ratios are measurements a company can use to identify whether it can pay off its current and long-term liabilities. A good liquidity ratio is anything greater than 1. The cash ratio compares just cash and readily convertible investments to current liabilities. Disadvantages of ratio analysis: x Ratios are based on past results and may not indicate how a business will perform in the future. Liquidity is important for any business. Hence, this ratio plays important role in assessing the health and financial stability of the business. Thus, liquidity suggests how quickly assets of a company get converted into cash. When analyzing a company, investors and creditors want to see a company with liquidity ratios above 1.0. If this ratio is low, this means that the company has low liquidity and is relying on its operating cash flow and loans to meet its obligations. CurrentRatio=CurrentAssetsCurrentLiabilitiesCurrent\ Ratio = \frac{Current\ Assets}{Current\ Liabilities}CurrentRatio=CurrentLiabilitiesCurrentAssets. They provide insight into a company's ability to repay its debts and other liabilities out of its liquid assets. Moreover, analysts prefer a liquidity ratio more than 1. Current Ratio = (Cash + Cash Equivalent) / Current Liabilities. 25 Luke St, London EC2A 4D, A software that adapts to your company challenges. Content Ratio over the Liquidity Index in predict-ing the shear strength of soils. The acid test ratio or the quick ratio calculates the ability to pay off current liabilities with quick assets. Solution Current ratio = Current assets/Current liabilities 1.5/1 = Current assets/$500,000 Current assets = 1.5 $500,000 Current assets = $750,000 3. If the current ratio were only 100%, this would mean that the company can just about service its liabilities with its current assets. On the other hand, if there are continuous defaults in repayment of a short-term liability, it can lead to bankruptcy. Liquidity ratios measure the ability of a business to meet its short-term current liabilities whereas in contrast solvency ratios assess its ability to pay off long-term obligations to creditors, bondholders, and banks. So, it can be said that the company's liquidity . Liquid assets. A high current ratio indicates that the company has good liquidity to meet its short-term obligations. d) profitability ratio. Liquidity ratios determine a company's ability to cover short-term obligations and cash flows,. 4. Although this means that you could only cover a small part of your liabilities with the most liquid funds, companies accept this risk for growth reasons. You can unsubscribe at any time by contacting us at help@freshbooks.com. This ratio takes an even more conservative measure to liquidity, and includes only cash, cash equivalents and short-term investments as liquid assets. In current ratio, we consider all current assets (cash, marketable . 50,000/50,000 = 1:1. This means that the company always has sufficient current assets available to meet its short-term liabilities. Burn Rate Days Cash on Hand Limitation: False Liquidity The liquidity ratios all compare current assets to current liabilities in some way. The various liquidity ratios can be calculated as below: Current ratio = (Total current assets / Total current liabilities) Current ratio = (10000 / 5700) = 1.75 Acid test ratio = (Total current assets - Stock) / Current liabilities)) Acid test ratio = (10000 - 3000) / 5700)) = 1.23 Cash ratio = (Cash and Cash Equivalent) / Current Liabilities) The company can pay its liabilities in full within a short time without having to liquidate assets from inventories. This indicates that the company can continue to meet its daily cash expenses for 50 days from the existing liquid assets. A high ratio indicates that the company is quite liquid. The current ratio is calculated by dividing current assets by current liabilities. 4. The quick ratio is similar to the current ratio, but it subtracts inventory from current assets before dividing it by current liabilities. A current ratio below 1 means that the company doesnt have enough liquid assets to cover its short-term liabilities. The higher the liquidity ratio the higher will be the margin of safety. Liquidity ratio analysis helps in measuring the short-term solvency of a business. Liquidity ratios are measurements used to examine the ability of an organization to pay off its short-term obligations. What does it mean when the acid test ratio is at 1?? Current Ratio = Total Current Assets / Total Current Liabilities, 2. Quick ratio is the same as current ratio except that it excludes inventory from the current assets. In simpler terms, we can say that liquidity ratio is a company's capability to turn current assets into cash quickly so that it can pay debts in a timely manner. The commonly used liquidity ratios are: current ratio, OWC/Sales and the cash ratio. CashRatio=CashandCashEquivalentsCurrentLiabilitiesCash\ Ratio = \frac{Cash\ and\ Cash\ Equivalents}{Current\ Liabilities}CashRatio=CurrentLiabilitiesCashandCashEquivalents. Liquidity ratios are important because they give analysts and creditors an idea of how easily a company can pay its short-term liabilities. Learning about the liquidity ratio can help you identify possible financial solutions and determine . This is among the important measurement which involves planning and controlling the current assets and current liabilities. As complicated as it may sound a liquidity ratio is nothing but the ability of a business or company to pay off its debts. These assets normally include cash, bank, and marketable securities. It is often used by lenders and potential creditors to measure business liquidity and how easily it can service debt. Explain experimental neurosis and discuss Shenger-Krestovnikova's procedure for producing it. Current Ratio = (Cash + Cash Equivalent) / Current Liabilities. The higher the ratio, the better the ability of a firm of pay off its obligations in a timely manner. It acts as a reserve. Investors use the liquidity ratio when considering a business as a potential investment. This is perhaps the best liquidity ratio for evaluating whether a business has sufficient short-term assets on hand to meet its current obligations. Liquidity ratios assess a company's ability to meet its short-term debt obligations. Internal analysis of liquidity ratios You may disable these by changing your browser settings, but this may affect how the website functions. Basic liquidity ratio = Monetary assets / monthly expenses Importance of Liquidity Ratio As a useful financial metric, the liquidity ratio helps to understand the financial position of a company. The liquidity ratio is the result of dividing the total cash by short-term borrowings. A few basic types of ratios used in ratio analysis are profitability ratios, debt or leverage ratios, activity ratios or efficiency ratios, liquidity ratios, solvency ratios, earnings ratios, turnover ratios . We show you here which different ratios there are, how to calculate them and what the ideal values are. The liquidity ratio has an impact on the credit rating as well as the credibility of the business. The account earns $8 \%$ compounded annually. What is the difference between cash asset ratio and other liquidity ratios? The difference between the two is that in the quick ratio, inventory is . To learn more about how we use your data, please read our Privacy Statement. Further, it ensures that a business has uninterrupted flow of cash to meet its current . They, therefore, usually use ending balance sheet data rather than averages. Its main flaw is that it includes inventory as a current asset. The quick ratio is the same as the current ratio, but excludes inventory. A high quick ratio indicates that the company has good liquidity to meet its short-term obligations. The liquidity coverage ratio is the requirement whereby banks must hold an amount of high-quality liquid assets that's enough to fund cash outflows for 30 days. Save Time Billing and Get Paid 2x Faster With FreshBooks. The liquidity ratio is a metric to measure the company's financial health. For example, in the US, the SLR for commercial banks is set by the Federal Reserve. If the business has a liquidity ratio of less than 1 they cannot pay back their current liabilities and will likely be ineligible for a loan. The formula for the quick ratio then looks like this: Quick ratio = (Cash + marketable securities + accounts receivables) / current liabilities x 100. NOTE: FreshBooks Support team members are not certified income tax or accounting professionals and cannot provide advice in these areas, outside of supporting questions about FreshBooks. Ratio analysis is also used by the readers of the financial statements for gaining a better understanding of the wellbeing of a company. This would mean that the company has twice as much money on hand as its short-term operational liabilities. That means the business has $2 for every $1 in liabilities. So, if the current assets amount to $400,000 and current liabilities are $200,000, the current ratio is 2:1. When cash asset ratio is high, it means that the company does not have any liquidity. Finance Train, All right reserverd. This ratio considers only quick assets for the purpose of existing liquid assets. If the current ratio is below 100%, this means that the company cannot repay its current liabilities with its current assets. The current ratio Current Ratio The current ratio is a liquidity ratio that measures how efficiently a company can repay it' short-term loans within a year. Consequently, most remaining assets should be readily convertible into cash within a short period of time. The Interpretation of Financial Statements. We will take a simple example to understand these ratios. There are several ratios available for this . The liquidity ratio helps to understand the cash richness of a company. There are three common calculations that fall under the category of liquidity . There are four important liquidity ratios: Current Ratio Quick Ratio Cash Ratio Defensive Interval Ratio All these ratios compare the company's short-term assets with its short-term liabilities, however, make use of short-term assets with varying levels of liquidity. Absolute Liquidity Ratio: Absolute liquidity is represented by cash and near cash items. The higher ratio, the higher is the safety margin that the business possesses to meet its current liabilities. The assets include only cash and cash equivalents, and short-term investments. However, if liquidity is interpreted more narrowly and the quick ratio is considered, the ratio is lower, but in the example it is still sufficient at 213%. This financial metric shows how much a company earns from its operating activities, per dollar of current liabilities. It means that that the business would have to improve the working capital of the business. A liquidity ratio is a type of ratio that allows you to determine how well a company can pay for its debt without having to use external funding sources. Liquidity ratio for a business is its ability to pay off its debt obligations. Liquidity ratio analysis & interpretation It means that that the business would have to improve the working capital of the business. it would mean that the company could just pay off its short-term debts from its most liquid assets. Another concern is that these ratios do not take into account the ability of a business to borrow money; a large line of credit will counteract a low liquidity ratio. It signifies a company's ability to meet its short-term liabilities with its short-term assets. These are the liquid funds that are available to the company very quickly, which is an advantage if an unexpected higher sum has to be paid at short notice. The acid test does not include stock because:-, Don Herrmann, J. David Spiceland, Wayne Thomas, Fundamentals of Financial Management, Concise Edition, Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield. It means that the business could have cash flow problems. The quick assets refer to the current assets of a business that can be converted into cash within ninety days. The liquidity ratio is a financial metric that shows if a company or a business can pay its short-term debt without raising cash (capital) from outside. A liquidity ratio has to do with the amount of cash and cash assets that a banking institution has on hand for conversion. The cash ratio formula is (cash + marketable securities) / current liabilities. To learn about how we use your data, please Read our Privacy Policy. The liquidity ratio is used to determine the credibility of a company. If it doesn't have enough liquid assets to sustain its day-to-day operations, it . Quick ratio. The most basic metric of liquidity is the current ratio which compares the business's current assets to its current liabilities. CFA Institute does not endorse, promote or warrant the accuracy or quality of Finance Train. There are four important liquidity ratios: All these ratios compare the companys short-term assets with its short-term liabilities, however, make use of short-term assets with varying levels of liquidity. If the business has a current ratio of at least 1, you can say that it is fairly liquid. There are a few banking sector ratios that can be computed to analyse the liquidity of the bank while analyzing banking stocks. The more liquid your business is, the better equipped it is to pay off short-term debts. For the cash ratio, 20% is a good benchmark. c) activity ratio. Quick ratio - This liquidity ratio is similar to the current ratio, but it only includes those assets that can be quickly converted into cash. The data used in this research are financial reports of 13 manufacture companies period 2009-2011 obtained from ICMD. This analysis is important for lenders and creditors, who want to gain some idea of the financial situation of a borrower or customer before granting them credit. What are the most common liquidity ratios The most common liquidity ratios are the current ratio and quick ratio. The current ratio is an indicator of your company's ability to pay its short term liabilities (debts). However, a higher ratio may also indicate that the cash resources are not being used appropriately since it could be invested in profitable investments instead of earning the risk-free rate of interest. But literature review (Bjerrum 1954) reveals that there exists denite relationship between Liquidity Index and Sensitiv-ity of clayey soils. The liquidity ratio is a financial metric which can determine a company's ability to pay off its short-term liabilities. 2022. For the purposes of calculating a liquidity ratio, a bank would consider only those assets that could be sold off and increase the cash on hand within a specified period of time. What is a good liquidity ratio? If the value of the ratio is higher, then the margin of safety that the company possesses to cover the debts is also bigger. However, this is not the case. Liquidity Ratio primarily consists of three financial ratios: Current Ratio, Quick Ratio or Acid Test Ratio, and Cash Ratio. a) solvency ratio . Current ratio formula. This means it helps in measuring a company's ability to meet its short-term obligations. We can now calculate the different liquidity ratios using the formulas from the previous section: Current ratio = (50,000 + 20,000 + 100,000 + 30,000) / 80,000 x 100 = 250% Quick ratio = (50,000 + 20,000 + 100,000) / 80,000 x 100 = 213% Cash ratio = = (50,000 + 20,000) / 80,000 x 100 = 88%. x Accounting results over time will be affected by inflation and . 50,000. Factor the following expressions completely. The intent behind using it is to see if there are sufficient current assets on hand to pay for current liabilities, if the current assets were to be liquidated. The higher ratio, the higher is the safety margin that the business possesses to meet its current liabilities. The current ratio compares current assets with current liabilities. Example: If you have assets of $1.2 million and liabilities of $1 million, your current ratio is 1.2. With the quick ratio, the same variables are considered as with the current ratio, only inventories are left out of the calculation. The current assets include all the current assets that we expect to convert to cash in one year. The quick ratio (sometimes called the acid-test) is similar to the current ratio. Compute current ratio, quick ratio and absolute liquid ratio from the following are the current assets and current liabilities of a trading company: Current assets: Cash and Bank: $5,000 A statutory liquidity ratio (SLR) is a percentage of liquid assets that a commercial bank or financial institution must retain daily. There are 3 different liquidity ratios that are current, quick and cash asset ratio. In the absolute liquidity ratio or cash ratio, accounts receivable and inventories are not included in the calculation: Cash ratio = (Cash + marketable securities) / current liabilities x 100. However, this need not be a cause for concern, as long as this situation does not become the norm. Liquidity ratios measure a company's ability to satisfy its short-term obligations. The Liquidity Coverage Ratio is a requirement under Basel III for a bank to hold high-quality liquid assets (HQLAs) sufficient to cover 100% of its stressed net cash requirements over 30 days. Current ratio is considered the most common and is calculated by dividing all assets into all liabilities. The higher the current ratio, the more funds the company has available and the better its liquid situation. Current ratio = Current assets / current liabilities x 100. An unexpectedly high bill could then quickly bring the company into payment difficulties. In most cases, it is an excessively conservative way to evaluate the liquidity of a business. More than 6000 clients already use Agicap! What does it mean when the ratio is less than 1? What does it mean when the ratio is less than 1? A good current ratio is between 1.2 to 2, which means that the business has 2 times more current assets than liabilities to covers its debts. One might think that a company should aim for the highest possible liquidity ratios. c) Short term solvency ratio . Common liquidity ratios include the quick ratio, current ratio, and days sales outstanding. How to Calculate Liquidity Ratio (Step-by-Step) Liquidity Ratio #1 Current Ratio Formula Liquidity Ratio #2 Quick Ratio Formula Liquidity Ratio #3 Cash Ratio Formula Liquidity Ratio #4 Net Working Capital % Revenue Formula Liquidity Ratio #5 Net Debt Formula What is Liquidity Ratio? QuickRatio=QuickAssetsCurrentLiabilitiesQuick\ Ratio = \frac{Quick\ Assets}{Current\ Liabilities}QuickRatio=CurrentLiabilitiesQuickAssets. This . Lower ratios could indicate liquidity problems, while higher ones could signal there may be too much working capital tied up in inventory. Each ratio looks at liquidity from a slightly different angle. $64+27 t^{3}$. We will take a simple example to understand these ratios. If a companys cash ratio is greater than 1, the business has the ability to cover all short-term debt and still have cash remaining. Current ratio = $140,000/$110,000 = 1.273. Liquidity Ratio. The quick ratio indicates the company's ability to service its short-term liabilities from the majority of its liquid assets. This ratio measures for how many days can a company pay its daily expenses only from the existing liquid assets assuming that the company does not receive any new cash flow. A current ratio of 1.5 to 3 is often considered good. Cash Flow: definition, calculation, principle, all you need to know! Current liabilities include all short-term liabilities, i.e. Three of the most common ones are: Current ratio - current assets divided by current liabilities Quick ratio - current assets minus inventory divided by current liabilities It is to be observed that receivables are excluded from the list of liquid assets. The liquidity ratio, then, is a computation that is used to measure a company's ability to pay its short-term debts. While analyzing the liquidity position of a company, an analyst uses the common liquidity ratios to measure the companys ability to pay-off its short-term liabilities. In other words, liquidity ratios are financial metrics allowing you to assess if the company can generate enough cash or has sufficient liquid reserves to pay for its debt obligations. Technical liquidity is normal evaluated on the basis of the following ratio in a human enterprise: a) current ratio It assumes that inventory cannot be easily converted into cash and hence is excluded from the liquid assets. Even in a crisis situation this ratio may not be reliable because the value of marketable securities can change drastically. Liquidity includes all assets that can be converted into cash quickly and cheaply. In order to explore the possibility of substituting WCR withI L (wherever relations exist with other geotechnical . What Is the Matching Principle and Why Is It Important? Calculate the different liquidity ratios from the following particulars Current Ratio= Current Assets/ Current Liabilities Current Assets = Sundry Debtors + Inventories + Cash-in-hand + Bills Receivable Current Liabilities = Creditors + Bank Overdraft Current Assets= 300,000 + 150,000+ 50,000+ 30,000= 530,000 problem. d) Profitability ratio. Lets say that we have the following data for a company. collect receivables. The quick ratio is the same as the current ratio, but excludes inventory. A high liquidity ratio means that the company is in a strong financial position and is unlikely to face difficulties in meeting its obligations. 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