Liquidity rates are used to measure the entity's ability to meet its short-term financial liabilities, ie the liquidity of a company. Short term refers to a period of 12 months or less. Two of the most important liquidity ratios are the current rate and the rapid rate. The current ratio or the current assets indicator formula is as follows:
Actual ratio = Short-term assets / current liabilities
The ratio of rapid ratios or acid test is as follows:
Quick Ratio = [Current Assets – Inventories – Prepaid Expenses] / [Current Liabilities – Bank Overdraft]
Basically, these ratios are related to the assets and liabilities that arise in day-to-day activities. The fast rate takes into account the most realizable assets and the transitional liabilities for short-term periods.
When calculating liquidity ratios, account should be taken of the bank's overdrafts or not. Overdrafts are usually short-term loans, which cover any temporary deficiencies in cash resources. Interest may only be charged on amounts levied on the basis of the allowed limits. Such interest is often developed at very short intervals and is usually variable. As the borrowing company needs to distribute its resources regularly to track interest rates and renegotiate the borrowing, overdrafts will only be taken if necessary. In addition, the overdraft facility can be withdrawn at any time. These factors take advantage of the essential short-term nature of this financing method. Therefore, most analysts consider the short-term liabilities as part of the current ratio. However, some people show different approaches.
Overdrafts are drawn on credit lines generally covering periods of more than one year and which are often renewed at maturity. In addition, most organizations use these tools as needed. More or less, these assets become a permanent source of funding. It is common practice that overdrafts can not be claimed and provide additional constancy. This explains why, as a convention, they are excluded from the calculation of the rapid rate.
The final decision that includes or excludes it depends on the particular circumstances of the particular case, for example, if a credit line is due to the fact that because of the expiration it does not intend to renew in the short term, it may be reasonable to include overdrafts in calculations. Likewise, if the overdraft facility can be committed on demand, this is part of the actual proportion and may be part of the rapid rate, subject to other details.