The table below shows two liquidity ratios calculated for Dilva Ltd for the past two years: multicolumn(1)(|c|)( Ratio ) & multicolumn(1)(c|)(2022) & multicolumn(1)(c|)(2021) Current ratio & 1.6: 1 & 1.2: 1 Quick (acid) ratio & 1.3: 1 & 1.1: 1 Which of the following statements is an incorrect interpretation of these ratios: There is no ideal current ratio that fits all businesses, different types of businesses in different sectors may require different current ratios. For a more stringent test of liquidity, inventory is excluded from the quick ratio calculation. In 2022, for every £ 1 of current liabilities, the company has £ 1.6 liquid assets and £ 1.3 current assets. The business is in a better liquidity position in 2022 compared to the year before. The ratios indicate that the company has sufficient liquid assets to meet its short-term obligations.

Question

The table below shows two liquidity ratios calculated for Dilva Ltd for the past two years: multicolumn(1)(|c|)( Ratio ) & multicolumn(1)(c|)(2022) & multicolumn(1)(c|)(2021) Current ratio & 1.6: 1 & 1.2: 1 Quick (acid) ratio & 1.3: 1 & 1.1: 1 Which of the following statements is an incorrect interpretation of these ratios: There is no ideal current ratio that fits all businesses, different types of businesses in different sectors may require different current ratios. For a more stringent test of liquidity, inventory is excluded from the quick ratio calculation. In 2022, for every £ 1 of current liabilities, the company has £ 1.6 liquid assets and £ 1.3 current assets. The business is in a better liquidity position in 2022 compared to the year before. The ratios indicate that the company has sufficient liquid assets to meet its short-term obligations.

Answer 1

The incorrect interpretation is the third statement: "In 2022 , for every £1 of current liabilities, the company has £1.6 liquid assets and £1.3 current assets." They should instead be seen as "In 2022 , for every £1 of current liabilities, the company has £1.6 of current assets and £1.3 of quick assets.”

Answer 2

## Step 1:The first statement is true: there's no ideal ratio fitting all businesses since financial circumstances vary from sector to sector, and business to business.## Step 2:The second statement is also true, as the quick ratio - also known as the acid-test ratio - excludes inventory from its calculation.## Step 3:The third statement is incorrect, because it misunderstands the concept of liquid and current assets. In this case, in 2022, for every £1 of current liabilities, the company has £1.6 of current assets and £1.3 of QUICK assets (quick assets are a subset of current assets). This means that the company can cover short-term obligations with its short-term assets excluding inventory.## Step 4:The fourth statement is correct, since both the current pitfall testing and quick ratio are higher in 2022 than in 2021, which means the company's liquidity position is better.## Step5:The fifth statement is also true because the current and quick ratios which are 1.6 and 1.3 respectively indicate that the company has sufficient liquid assets to cover its short-term liabilities.### Formulas involved: - The Current Ratio =

- The Quick (acid-test) Ratio =

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