absolute liquid ratio

ABSOLUTE LIQUID RATIO FORMULA

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ABSOLUTE LIQUID RATIO FORMULA

Absolute Liquid Ratio is a type of liquidity ratio that is calculated to analyze the short term solvency or financial position of the firm. It is calculated to exclude the receivables from the current and liquid assets and to know about the absolute liquid assets. Although receivables, debtors and bills receivables are generally more liquid than inventories, yet there may be doubts regarding their realization into cash immediately or on time as there are the chances of bad debts. To exclude this possibility, absolute ratio is calculated. The absolute liquid ratio is also known as Cash ratio. The absolute liquid ratio formula is:

Absolute Liquid Ratio= Absolute Liquid Assets/ Current Liabilities

ABSOLUTE LIQUID ASSETS: The assets included in absolute liquid assets are as follows:

  • Cash in Hand: Cash in hand means the cash available with the business house at a point of time.
  • Cash at Bank: Cash at bank means the cash that is with the business by the way of deposits in the bank accounts may it be saving account, current account or any kind of other account.
  • Marketable Securities: Marketable Securities are those securities that can be readily converted in to the cash by sale. These are generally traded in the money market. These securities are also known as temporary investments.

CURRENT LIABILITIES: Current liabilities are the liabilities payable within 12 months from the date of balance sheet or within the period of operating cycle. Current liabilities include the following liabilities:

  • Short term borrowings: Short term borrowings are those borrowings that the business house has to repay within 12 months or a year. These borrowings may be secured or unsecured.
  • Trade payables i.e. creditors and bills payable: Trade Payables includes the creditors or bills payable. Creditors are the persons from whom the business purchases the goods on credit and make guarantee to repay their payment on some future date.
  • Short term provisions:  The provisions like provision for doubtful debts, provisions for repairs, provision for taxation are short term provisions. These made to meet any short term liability that might arise in the future.
  • Outstanding expenses: The expenses which have become due but are not paid yet are Outstanding Expenses. Example of these expenses is: Salary due but not paid, Electricity bill due but not paid, etc.
  • Incomes received in advance: The incomes received in advance makes the business house liable to perform the contract.

IDEAL ABSOLUTE LIQUID RATIO

The ideal standard for this ratio is 0.5:1 i.e. 50%. This means Rs. 1 worth absolute liquid assets are considered adequate to pay Rs. 2 worth current liabilities in time as all the creditors are not expected to demand cash at the same time and then cash may also be realized from debtors and inventories.

EXAMPLE: Suppose the firm has following assets and liabilities:

Goodwill 50,000 Cash at bank 30,000
Plant and machinery 4,00,000 Inventories 75,000
Trade investments 2,00,000 Bank overdraft 70,000
Marketable securities 1,50,000 Sundry creditors 60,000
Bills receivables 40,000 Bills payable 90,000
Cash in hand 45,000 Outstanding expenses 30,000

Absolute Liquid Ratio= Absolute Liquid Assets/ Current Liabilities

Absolute liquid assets= marketable securities+ cash in hand+ cash at bank

=1,50,000+ 45,000+ 30,000

=2,25,000

Current Liabilities= Bank Overdraft+ Sundry Creditors + Bills payable+ Outstanding expenses

= 70,000+ 60,000+ 90,000+30,000

= 2,50,000

Absolute liquid ratio= 2,25,000/ 2,50,000

= 0.9.

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