liquidity ratio

Accounting ratio that is used to measure a company's ability to meet short-term debts. The liquidity ratio is calculated by dividing current assets minus stock by current liabilities. If a company has assets of £10,000 and liabilities of £20,000, the liquidity ratio is 0.5 or 50 pence in the pound. If the company were forced by its creditors to pay its debts it would be unable to pay them and would therefore be insolvent.

Although stocks are a current asset, they are relatively illiquid: a company might find it difficult to obtain cash for its stocks at short notice. The acid test ratio measures the ratio of liquid current assets to current liabilities, excluding the less liquid stocks. It is a tighter measure of liquidity than the current ratio. The lower the acid test ratio, the more likely it is that the firm will become insolvent and have to declare itself bankrupt.