Absolute Liquid Ratio (ALR) Explained & Calculated with Example

CHAPTER 2 Financial Statement Analysis Unit 7 Module 3 Liquidity ratios Absolute Liquid Ratio (ALR)

Absolute Liquid Ratio: is a stringent liquidity metric that evaluates a company's ability to meet its short-term liabilities with its most liquid assets, specifically cash and cash equivalents, plus marketable securities. This ratio provides a clear picture of a company's immediate liquidity position by focusing solely on assets that can be quickly converted to cash.

Formula
Absolute Liquid Ratio

Cash and Cash Equivalents + Marketable Securities / Current Liabilities

Meaning
The Absolute Liquid Ratio indicates how well a company can cover its current liabilities using only the most liquid assets. A ratio of 1 or more suggests that the company can fully meet its short-term obligations without relying on inventory or receivables.
Implication
A higher Absolute Liquid Ratio implies strong liquidity, demonstrating that the company has ample cash or marketable securities to pay off its current debts. Conversely, a lower ratio may raise concerns about the company's ability to address short-term obligations promptly.
Cause & Effect
High Absolute Liquid Ratio:
Causes: Substantial holdings in cash and marketable securities, effective cash management strategies, or a conservative approach to financing.
Effects: Enhanced financial stability, increased investor confidence, and improved ability to respond to unexpected financial challenges.
Low Absolute Liquid Ratio:
Causes: Limited cash or marketable securities, high current liabilities, or inefficiencies in cash flow management.
Effects: Increased risk of liquidity problems, potential difficulties in meeting short-term debts, and adverse effects on credit ratings.

Conclusion
The Absolute Liquid Ratio is a vital measure of a company's liquidity, highlighting its capacity to meet short-term liabilities with only its most liquid assets. Monitoring this ratio helps stakeholders gauge the company's financial resilience and readiness to handle immediate obligations without depending on less liquid assets.

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