Classification of Liquidity Ratios:

1. Current Ratio
2. Liquid Ratio

Meaning, Objective and Method of Calculation:

1. Current Ratio: Current ratio is calculated in order to work out firm’s ability to pay off its short-term liabilities. This ratio is also called working capital ratio. This ratio explains the relationship between current assets and current liabilities of a business. Where current assets are those assets which are either in the form of cash or easily convertible into cash within a year. Similarly, liabilities, which are to be paid within an accounting year, are called current liabilities.




Current Ratio		Current Assets
	=
		Current Liabilities

Current Assets include Cash in hand, Cash at Bank, Sundry Debtors, Bills Receivable, Stock of Goods, Short-term Investments, Prepaid Expenses, Accrued Incomes etc.

Current Liabilities include Sundry Creditors, Bills Payable, Bank Overdraft, Outstanding Expenses etc.

Objective and Significance: Current ratio shows the short-term financial position of the business. This ratio measures the ability of the business to pay its current liabilities. The ideal current ratio is suppose to be 2:1 i.e. current assets must be twice the current liabilities. In case, this ratio is less than 2:1, the short-term financial position is not supposed to be very sound and in case, it is more than 2:1, it indicates idleness of working capital.

2. Liquid Ratio: Liquid ratio shows short-term solvency of a business in a true manner. It is also called acid-test ratio and quick ratio. It is calculated in order to know how quickly current liabilities can be paid with the help of quick assets. Quick assets mean those assets, which are quickly convertible into cash.
   
   

   Liquid Ratio		Liquid Assets
   	=
   		Current Liabilities

   
   Where liquid assets include Cash in hand, Cash at Bank, Sundry Debtors, Bills Receivable, Short-term Investments etc. In other words, all current assets are liquid assets except stock and prepaid expenses.
   
   Current liabilities include Sundry Creditors, Bills Payable, Bank Overdraft, Outstanding Expenses etc.
   
   Objective and Significance: Liquid ratio is calculated to work out the liquidity of a business. This ratio measures the ability of the business to pay its current liabilities in a real way. The ideal liquid ratio is suppose to be 1:1 i.e. liquid assets must be equal to the current liabilities. In case, this ratio is less than 1:1, it shows a very weak short-term financial position and in case, it is more than 1:1, it shows a better short-term financial position.