Short-term Solvency Ratio Analysis
Definition: Short-term solvency ratios are used to measure the ability of a company to meet its short-term financial obligations. These ratios are the Current Ratio and the Acid-Test Ratio.
Formula:
1) Current ratio = Total Current Assets / Total Current Liabilities
2) Acid test ratio = (Current Assets - Inventory) / Current Liabilities
Example:
Use the following information to calculate the relevant short-term solvency ratios:
Trade debtors $12,000
Trade creditors $35,000
Closing inventory $20,000
Cash $18,000
Bank overdraft $5,000
Solution:
Current assets = debtors + inventory + cash = 12,000 + 20,000 + 18,000 = $50,000
Current liabilities = creditors + bank overdraft = 35,000 + 5,000 = $40,000
Current ratio = 50,000 / 40,000 = 1.25
Acid test ratio = (50,000 - 20,000) / 40,000 = 0.75
Formula:
1) Current ratio = Total Current Assets / Total Current Liabilities
2) Acid test ratio = (Current Assets - Inventory) / Current Liabilities
Example:
Use the following information to calculate the relevant short-term solvency ratios:
Trade debtors $12,000
Trade creditors $35,000
Closing inventory $20,000
Cash $18,000
Bank overdraft $5,000
Solution:
Current assets = debtors + inventory + cash = 12,000 + 20,000 + 18,000 = $50,000
Current liabilities = creditors + bank overdraft = 35,000 + 5,000 = $40,000
Current ratio = 50,000 / 40,000 = 1.25
Acid test ratio = (50,000 - 20,000) / 40,000 = 0.75