A tutorial question and its suggested solution was:

The current and quick (acid test) ratios are both measures of what? Which of the two ratios is a stricter test, and how does it accomplish this?

Solution: These are liquidity ratiosassessments of how well the business can meet short-term commitments or claims against the assets when they fall due. These ratios are sometimes expressed in terms of the ability or speed with which assets can be converted to cash.

The acid test is the more stringent of these two ratios. It does this by not including inventory or prepayments as assets that can readily be turned into cash.

Required:

In your own words, explain (i) why liquidity analysis of a company is important and (ii) why inventory and/or prepayments are excluded in the calculation of the acid test ratio.