2,60,000 Liquid ratio Liquid assets 0.37 : 1 Current liabilities 7,00,000 (6) Liquidity is the desire to hold assets in the form of cash. Liquidity is crucial to survival and success. Liquidity may be desired for the following reasons: (1) The transactions motive, i.e., to carry out future monetary transactions (2) The precautionary motive, i.e., to avoid future uncertainties. (3) The speculative motive, i.e., to take advantage of movements in the price level. Comment X Co Ltd is experiencing liquidity problems. The current ratio of 1.08 to 1 is very low. The liquid ratio of 0.37 to I suggests that great problems with short-term finance may be experienced. If the bank overdraft is excluded from current liabilities, the liquid ratio becomes 0.99 to 1 -- which is more respectable. However, this highlights the dependence of the company on the bank as a source of working capital. The payment of income tax or dividend will cause the liquidity position to deteriorate. (e) The current and liquid ratios are the tests of the business's ability to meet its obligations in the short run. A company would expect to pay current obligations out of immediate cash resources or those provided by receipts from debtors. It would be undesirable if creditors could only be paid by an enforced sale of productive plant and machinery or other fixed assets. It should not be overlooked that it is also undesirable for current and liquid ratios to grow too large. This is a symptom of surplus cash which does imply that expensive resources are being kept idle. Illustration 78 The information given below relates to ABC Ltd for the year ended 31.12.2017: (1) Opening inventories 60,000; Closing inventories ? 75,000; Sales 10,00,000. (ii) Rate of inventories turnover: 12 times in the year. You are asked to : (1) Calculate the gross profit ratio. (2) Give reasons for changes in gross profit ratio. (3) What are the points to be remembered while calculating gross profit ratio? (4) State what action should be taken for an unexpected reduction in the gross profit ratio? (5) The gross profit ratio of a company has gone up from 20% to 25%. What reservations would you have about judging this figure as favourable sign and what other information would you seek before doing so ? e49