Practice Flashcards
Flip to reveal answersWhat is the current ratio formula?
Track your progress — Sign up free to save your progress and get smart review reminders based on spaced repetition.
All 30 Flashcards — Liquidity ratios
Sign up free to track progress and get spaced-repetition review schedules.
Question
What is the current ratio formula?
Answer
Current ratio = Current assets ÷ Current liabilities (expressed as ratio e.g. 2:1)
💡 Hint
CA ÷ CL
Question
CA $45k (Stock $25k, Rec $15k, Cash $5k), CL $30k. Both ratios?
Answer
CR = 45/30 = 1.5:1 ✓. AT = (45-25)/30 = 0.67:1 ⚠️ below ideal.
💡 Hint
CR 1.5, AT 0.67
Question
What is liquidity?
Answer
The ability of a business to meet its short-term debts as they fall due — can it pay bills on time?
💡 Hint
Pay bills on time?
Question
Name three ways to improve liquidity
Answer
Collect debts faster, negotiate longer supplier terms, sell excess stock, inject capital, arrange overdraft.
💡 Hint
Cash in faster, out slower
Question
State both liquidity formulas and ideal ranges
Answer
CR = CA ÷ CL (1.5–2:1). AT = (CA − Stock) ÷ CL (~1:1).
💡 Hint
CR: 1.5-2. AT: ~1
Question
What is the acid test ratio formula?
Answer
Acid test = (Current assets − Stock) ÷ Current liabilities
💡 Hint
CA minus Stock ÷ CL
Question
Key difference between current ratio and acid test?
Answer
Acid test excludes stock — it's stricter because stock may not sell quickly.
💡 Hint
AT removes stock
Question
CA $60k, CL $30k. Calculate current ratio.
Answer
$60k ÷ $30k = 2:1. Business has $2 of current assets per $1 of short-term debt.
💡 Hint
60/30 = 2:1
Question
True or false: A profitable business can never run out of cash
Answer
False — it can be profitable but illiquid if cash is tied up in stock or receivables. Liquidity ≠ profitability.
💡 Hint
Profitable but no cash
Question
CR 1.5:1 but AT 0.67:1 — what's the problem?
Answer
Without selling stock, can't cover debts. Heavily reliant on inventory — risky if stock doesn't sell.
💡 Hint
Stock-dependent
Question
Why does the acid test exclude stock?
Answer
Stock may be hard to sell quickly and isn't truly liquid — tests if debts can be paid WITHOUT selling stock.
💡 Hint
Stock isn't liquid
Question
How does collecting debts faster improve liquidity?
Answer
Reduces receivables and brings cash in sooner — increasing liquid current assets.
💡 Hint
Receivables → cash sooner
Question
Why calculate BOTH liquidity ratios?
Answer
A healthy CR can hide a weak AT if the business holds lots of stock.
💡 Hint
CR can mask AT weakness
Question
What are liquid assets?
Answer
Cash or near-cash items that can quickly pay debts — cash in bank, receivables (NOT stock).
💡 Hint
Cash or quickly converted
Question
What is the ideal current ratio range?
Answer
1.5:1 to 2:1 — enough to pay debts with a buffer but not too much idle cash.
💡 Hint
1.5 to 2
Question
CA $60k, Stock $20k, CL $30k. Calculate acid test.
Answer
($60k − $20k) ÷ $30k = 1.33:1
💡 Hint
40k ÷ 30k
Question
How do longer supplier payment terms help liquidity?
Answer
Delays cash outflows — more time to collect income before paying bills.
💡 Hint
Pay later = keep cash longer
Question
Liquidity = ability to pay ___-term debts
Answer
Short-term
💡 Hint
Short
Question
Why does context matter for liquidity ratios?
Answer
Different industries have different norms — supermarkets safely run low acid tests due to fast turnover.
💡 Hint
Industry norms vary
Question
Why might a profitable business still fail?
Answer
If it lacks enough liquid assets to pay suppliers, staff and short-term obligations on time.
💡 Hint
No cash to pay bills
Question
Current ratio below 1:1 means what?
Answer
Danger — the business cannot cover short-term debts with current assets.
💡 Hint
Can't pay bills
Question
Healthy CR but weak AT means what?
Answer
Lots of stock relative to other current assets — depends on selling inventory to pay bills.
💡 Hint
Too much stock
Question
What is the ideal acid test ratio?
Answer
Around 1:1 — can pay debts without relying on selling stock.
💡 Hint
Around 1:1
Question
Summarise liquidity improvement in one phrase
Answer
Get cash IN faster and push cash OUT slower — it's all about timing.
💡 Hint
In faster, out slower
Question
Most common liquidity ratio exam mistake?
Answer
Just calculating without interpreting — always state ideal, compare, and recommend.
💡 Hint
Calculate + interpret + recommend
Question
Why sell stock at a discount for liquidity?
Answer
Converts illiquid stock into immediate cash — solves short-term crisis even at reduced prices.
💡 Hint
Cash now > full price later
Question
Can a loss-making business have plenty of cash?
Answer
Yes — e.g. if it received a large loan or sold assets. Cash ≠ profit.
💡 Hint
Loan gives cash
Question
Why might a current ratio much above 2:1 be bad?
Answer
Too much cash/stock sitting idle — the business is inefficient with its resources.
💡 Hint
Idle resources
Question
After calculating ratios, always do these three things:
Answer
State the ideal range, explain if above/below/within it, say what the business should DO.
💡 Hint
Ideal → Compare → Action
Question
Why can supermarkets survive with very low acid test ratios?
Answer
They sell stock quickly for cash every day — their stock IS liquid in practice. Industry context matters.
💡 Hint
Fast turnover = OK
Read the notes
Full study notes for Liquidity ratios
Topic 3.5 hub
Profitability and liquidity ratio analysis
More from Topic 3.5
All flashcards in this topic
BM exam skills
Paper structures & tips
Track your progress with spaced repetition
Sign up free — Aimnova tells you exactly which cards to review and when, so you remember everything before your IB exam.
Start Free