Liquidity ratios are based on current assets and current liabilities. Having a liquidity ratio of 1.5...

Liquidity ratios are based on current assets and current liabilities. Having a liquidity ratio of 1.5 when the industry average is 1.9 would be deemed as having better than average liquidity relative to the industry. True or false? (Explain)

Expert Solution

Liquidity ratio = current assets / current liabilities

Ans- False

Liquidity ratios are based on current assets and current liabilities. Having a liquidity ratio of 1.5 when the industry average is 1.9 would not be deemed as having better than average liquidity relative to the industry.

If the liquidity ratio of the industry is 1.9, it means that the average industry has a good amount of liquidity in hand to pay off its current liabilities, A liquidity ratio may vary from industry to industry. Ideally, a liquidity ratio of 1.5-2 is considered good. As the company has a liquidity ratio of 1.5, which is lower than the industry average, it has less amount of liquidity compared to the market.

Creditors usually prefer a liquidity ratio that is high because that indicates that you are well off to pay their debt. A very high liquidity ratio is also not considered as good because that means you are holding working capital in huge quantity that you can invest elsewhere.

hence having a liquidity ratio of 1.5 generally is not bad but as compared to the industry average of 1.9, you have lower than average liquidity in the industry.

jeff jeffy answered 1 year ago

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