Assess liquidity with current and acid test ratios
Calculate and interpret Cambridge's current and acid test ratios, assess short-term payment capacity and select context-sensitive improvements.
Cambridge International AS & A Level Business 9609, 2026–2028 syllabus and 2029 syllabus, section 10.2.1. Ratio calculations use the formulae listed in the relevant Cambridge syllabus. Written practice is self-checked. Specialist review has not been completed for this lesson; these exercises do not award an official mark or establish exam readiness.
Before you begin
- Read the figures, dates and assumptions supplied in the question before calculating or interpreting an accounting result.
Work on paper. Try each question before revealing help, and explain why your method works.
Quick readiness check
What does the acid test exclude from current assets?
What you will learn
- Explain why liquidity matters to short-term obligations
- Calculate current and acid test ratios using the prescribed formulae
- Interpret the figures and assess ways to improve liquidity
Liquidity concerns near-term payment
Liquidity is the ability to meet obligations as they fall due. A business can report accounting profit but still face a cash shortage if customers pay late or cash is tied up in inventory. Suppliers, staff and lenders can be affected by poor liquidity.
Current ratio = current assets ÷ current liabilities. Acid test ratio = (current assets−inventory) ÷ current liabilities. Present both as ratios. The acid test removes inventory because it may take time or a discount to turn stock into cash.
Interpret the composition and context
A higher ratio can indicate more short-term cover, but a target is not universal: business model, season, customer payment patterns, stock turnover and access to finance matter. A high current ratio may hide obsolete inventory or uncollected receivables; a low result is a prompt to investigate timing and quality of assets.
Possible improvements include speeding up collections, controlling inventory, negotiating payment timing, arranging suitable longer-term funding or retaining cash. Each has a cost: stricter credit can lose customers, lower stock can interrupt sales, and delaying suppliers may harm relationships.
Pause and explain
Current assets are $150,000, inventory $30,000 and current liabilities $100,000. What is the acid test ratio?
Worked example
A wholesaler has current assets of $120,000 including inventory of $44,000, and current liabilities of $80,000. Calculate both ratios and compare their signals.
Show the worked solution
- Current ratio=120,000÷80,000=1.5.
- Quick assets=120,000−44,000=$76,000.
- Acid test=76,000÷80,000=0.95; present as ratios and discuss asset mix.
Answer Current ratio is 1.5:1 and acid test ratio is 0.95:1. The difference reflects inventory; whether this is adequate depends on how reliably stock sells and obligations fall due.
Try a topic test
Choose Easy, Normal or Difficult. Save your answers and open worked review after finishing.
Test this topic →From guided practice to a new situation
Write your answer and reasoning first. Use a hint only if you are stuck. The model solution is for self-checking; your written work is not automatically marked.
Current assets are $96,000, including inventory of $24,000; current liabilities are $64,000. Calculate current and acid test ratios.
Give me a hint
Divide current assets, then current assets less inventory, by current liabilities.
Compare my reasoning
- Current ratio=96,000÷64,000.
- Quick assets=96,000−24,000.
- Acid test=72,000÷64,000.
Current ratio=1.5:1. Acid test ratio=1.125:1 (about 1.13:1).
Look for these in your work
- Current ratio uses all current assets
- Inventory is removed for the acid test
- Both are expressed as ratios
A retailer's current ratio rises because unsold seasonal stock builds up, while its acid test ratio falls. What should a manager investigate before concluding liquidity improved?
Give me a hint
Look at the quality and timing of the current assets, not only the total.
Compare my reasoning
- Check whether stock is saleable at expected prices.
- Review cash balances, receivable collection and liabilities due dates.
- Consider seasonal demand and whether inventory is tying up cash.
The rise may reflect inventory that is slow-moving or may need discounting, while the falling acid test suggests fewer liquid assets relative to short-term liabilities. The manager should examine stock age and sell-through, cash, customer receipts, payment dates and seasonal demand before deciding liquidity improved.
Look for these in your work
- Inventory quality is considered
- Near-term cash timing is checked
- A contextual conclusion is reached
A firm proposes delaying supplier payments to improve its current ratio. Assess one benefit and one risk, then suggest a complementary action.
Give me a hint
Explain the short-term liability effect and the relationship consequence.
Compare my reasoning
- Later payment may reduce immediate cash pressure if terms permit.
- Overdue payments may damage trust, supply or credit terms.
- Pair lawful negotiation with improved collections or stock control.
Negotiating longer agreed terms may ease short-term cash pressure, but simply paying late can damage supplier relationships, interrupt inputs or remove discounts. The firm could also improve receivables collection or reduce excess stock, with care not to harm customer service or sales.
Look for these in your work
- Cash benefit is conditional
- Supplier risk is concrete
- Complementary action has trade-offs
Common mistakes
- Presenting the current ratio as a percentage
- Including inventory in the acid test numerator
- Assuming a single ratio target suits every industry
What can you explain now?
What does the acid test exclude from current assets?
Compare with the explanation
Inventory
It focuses on current assets other than inventory when assessing near-term cover.
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Make it stick
How do the current and acid test ratios differ, and what evidence makes an interpretation useful?
If you needed the solution, close it and solve the problem again from a blank page. A correct answer is stronger when you can explain the reason for each step.