Question

What are the different types of liquidity ratios
A. Interest coverage ratio 
B. Current ratio 
C. Inventory turnover ratio 
D. Gross profit ratio 
E. Acid test ratio 
Choose the correct answer from the options given below:

• A. A & B only
• B. B & E only
• C. B & D only
• D. D & E only

Answer 1

The Correct Option is B

Step 1: Understand the Concept of Liquidity Ratios

Liquidity ratios measure a company’s ability to meet its short-term obligations (debts due within one year) using its short-term assets. They assess the company’s financial health in terms of liquidity—how easily it can convert assets into cash to pay off liabilities. Common liquidity ratios include:

• Current Ratio: Measures the ability to pay current liabilities with current assets.
• Acid Test Ratio (Quick Ratio): A stricter measure, excluding inventory from current assets.
• Cash Ratio: Focuses only on cash and cash equivalents (not listed here).

Step 2: Evaluate Each Ratio in the List

• A. Interest coverage ratio: This ratio measures a company’s ability to pay interest on its debt, calculated as Earnings Before Interest and Taxes (EBIT) ÷ Interest Expense. It’s a solvency ratio, focusing on long-term debt obligations, not a liquidity ratio. Incorrect.
• B. Current ratio: Calculated as Current Assets ÷ Current Liabilities, it measures the ability to pay short-term liabilities with short-term assets. This is a classic liquidity ratio. Correct.
• C. Inventory turnover ratio: Measures how efficiently a company manages its inventory, calculated as Cost of Goods Sold ÷ Average Inventory. It’s an efficiency ratio, not a liquidity ratio. Incorrect.
• D. Gross profit ratio: Calculated as Gross Profit ÷ Net Sales × 100, it measures profitability. It’s a profitability ratio, not a liquidity ratio. Incorrect.
• E. Acid test ratio: Also known as the quick ratio, it’s calculated as (Current Assets - Inventory) ÷ Current Liabilities. It measures the ability to pay short-term liabilities with quick assets, making it a liquidity ratio. Correct.

Step 3: Identify the Liquidity Ratios

From the list:

• Current ratio (B): A liquidity ratio.
• Acid test ratio (E): A liquidity ratio.
• Interest coverage ratio (A): Not a liquidity ratio (solvency ratio).
• Inventory turnover ratio (C): Not a liquidity ratio (efficiency ratio).
• Gross profit ratio (D): Not a liquidity ratio (profitability ratio).

The liquidity ratios are B (Current ratio) and E (Acid test ratio).

Step 4: Compare with the Options

• Option 1: A & B only: A (incorrect), B (correct). Since A is not a liquidity ratio, this option is wrong.
• Option 2: B & E only: B (correct), E (correct). Both are liquidity ratios, so this option is correct.
• Option 3: B & D only: B (correct), D (incorrect). Since D is not a liquidity ratio, this option is wrong.
• Option 4: D & E only: D (incorrect), E (correct). Since D is not a liquidity ratio, this option is wrong.

Step 5: Select the Correct Answer

The liquidity ratios are B (Current ratio) and E (Acid test ratio). Therefore, the correct answer is:

Option 2: B & E only

Final Answer

The correct answer is Option 2: B & E only.