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Absolute Liquid Ratio:

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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.

More study material from this to
 

More study material from this topic:

Meanings, Nature and Usefulness of Ratios Analysis
Interpretation of Ratios
Important Factors for Understanding Ratios Analysis
Significance and Usefulness Ratios Analysis
Classification of Ratios
Analysis of Short Term Financial Position or Test of Liquidity
Current Ratio
Quick/Acid Test/Liquid Ratio
Absolute Liquid Ratio
Inventory/Stock Turnover Ratio
Debtors / Receivable Turnover Ratio
Creditors / Payables Turnover Ratio
Working Capital Turnover Ratio
Profitability Ratios
Gross Profit Ratio (GP Ratio)
Operating Profit Ratio
Net profit ratio (NP ratio)
Earnings Per Share Ratio
Operating ratio
Expense ratio
Solvency ratios - Test of Long Term Solvency
Debt-equity Ratio
Debt Service Ratio or Interest Coverage Ratio
Fixed Assets Ratio
Debts to Total Funds or Solvency Ratio
Reserves to Capital Ratio
Capital Gearing Ratio
Proprietary Ratio
Accounting Ratios Formulas
Limitations of Ratios Analysis

 

 
 

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Financial Accounting Topics


  Introduction to Accounting
 ----------------------------------------------------------------------------
  Transactions and Accounting Equation
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  Analysis of Business Transactions
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  Journal, Ledger and Trial Balance
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  Accounting for Bills of Exchange
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  Special Journals
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  Cash Book
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Bank Reconciliation Statement
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  Final Accounts
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  Work Sheet
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  Capital and Revenue Items
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  Valuation of Inventories
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  Accounts of Non-profit Making Organizations
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  Statement of Cash Flows
----------------------------------------------------------------------------
  Accounting Ratios Analysis
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  Depreciation, Provisions and Reserves
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  Accounting Dictionary
----------------------------------------------------------------------------
  Financial Calculators
 
 
 
Managerial Accounting Topics

  Financial Statements
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  Cost Volume Profit Relationship
----------------------------------------------------------------------------
  Variable Costing System
----------------------------------------------------------------------------
  Materials and Inventory Cost Control
----------------------------------------------------------------------------
  Activity Based Costing System
----------------------------------------------------------------------------
  Standard Costing and Variance Analysis
----------------------------------------------------------------------------
  Balanced Scorecard
----------------------------------------------------------------------------
  Capital Investment Analysis/Capital Budgeting
 
 

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