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Liquidity ratios

A liquid asset can be converted to cash quickly without significantly impacting the asset’s value.

Which of the following asset classes is generally considered to be the most liquid?

Cash

Accounts receivable

Inventories


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In the event of a liquidation, inventories tend to recover the least amount of their stated value. Accounts receivable are likely to retain their value if there are no bad debts. But cash is already liquid, so it will not lose value.

That is why the quick ratio adjusts current assets by subtracting inventories. Whereas the current ratio compares current assets expected to be converted to cash in the next year to current liabilities expected to be due in the next year, the quick ratio asks what would happen if the firm were liquidated today and whether it would have enough liquid assets to meet short-term creditors.


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Answer #1

Cash

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