Definition and Explanation:
Absolute liquid ratio extends the
logic further and eliminates accounts receivable (sundry debtors and bills
receivables) also. Though receivables are more liquid as comparable to inventory
but still there may be doubts considering their time and amount of realization.
Therefore, absolute liquidity ratio relates cash, bank and marketable securities
to the current liabilities. Since absolute liquidity ratio lays down very strict
and exacting standard of liquidity, therefore, acceptable norm of this ratio is
50 percent. It means absolute liquid assets worth one half of the value of
current liabilities are sufficient for satisfactory liquid position of a
business. However, this ratio is not as popular as the previous two ratios
discussed.
Formula:
Absolute liquid ratio is calculated by using
the following formula:
Absolute liquid ratio = Absolute
liquid assets / Current liabilities
Where absolute liquid assets =
Cash + Bank + marketable securities.
Example:
From the following balance sheet calculate
absolute liquid ratio:
|
Liabilities |
$ |
Assets |
$ |
| Share capital |
5,00,000 |
Goodwill |
50,000 |
| Reserves |
1,90,000 |
Plant & machinery |
4,00,000 |
| Bank overdraft |
1,00,000 |
Trade investments |
2,00,000 |
| Sundry creditors |
1,40,000 |
Marketable securities |
1,50,000 |
| Bills payable |
50,000 |
Bills receivable |
40,000 |
| Outstanding expenses |
10,000 |
Cash |
45,000 |
| |
|
Bank |
30,000 |
| |
|
Inventories |
75,000 |
| |
|
|
|
| |
9,90,000 |
|
9,90,000 |
Solution:
Absolute liquid assets Absolute
liquid ratio = Absolute liquid assets/Current liabilities
Absolute liquid assets are
marketable securities, cash and bank. Thus $1,50,000 + $45,000 + $30,000 =
$2,25,000
Current liabilities are bank
overdraft, sundry creditors, bills payable and creditors for outstanding
expenses. = 1,00,000 + 1,40,000 + 50,000 + 10,000 = $3,00,000.
Absolute liquid ratio = 2,25,000
/ 3,00,000 = 0.75
The absolute liquid ratio in this case is 0.75
which is better as compared to rule of thumb standard which is 0.50. |
