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How do liquidity and gearing ratios measure whether a business can pay its short-term debts and how heavily it relies on borrowed funds?

Calculate and interpret the current ratio, quick ratio, debt to equity and equity ratio, and explain what they reveal about short-term solvency and financial stability

WACE Year 12 Accounting and Finance Unit 4 on liquidity and gearing: the current ratio and quick ratio for short-term solvency, and the debt to equity and equity ratios for financial stability, with calculation and interpretation of each.

Generated by Claude Opus 4.76 min answerUpdated 2026-05-29

Reviewed by: AI editorial process; not yet individually human-reviewed

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What this dot point is asking
Liquidity ratios
Gearing and stability ratios

What this dot point is asking

SCSA wants you to calculate each ratio, interpret short-term solvency and long-term stability, and weigh the trade-offs of gearing.

Liquidity ratios

The current ratio shows how many dollars of current assets back each dollar of current liabilities. The quick ratio (acid test) removes inventory, which can be slow to convert to cash, giving a stricter view of immediate solvency.

Gearing and stability ratios

The debt to equity ratio shows borrowed funds relative to owners' funds. The equity ratio shows what share of assets is financed by owners rather than creditors, so a higher equity ratio means greater stability.

Calculating liquidity and gearing

Brae Ltd reports current assets $150 000 (including inventory$ 60 000), current liabilities $75 000, total liabilities$ 200 000, total equity $300 000 and total assets$ 500 000.

Current ratio:

\frac{150\,000}{75\,000} = 2.0 \text{ to } 1

Quick ratio:

\frac{150\,000 - 60\,000}{75\,000} = \frac{90\,000}{75\,000} = 1.2 \text{ to } 1

Debt to equity:

\frac{200\,000}{300\,000} \times 100 = 66.7\%

Equity ratio:

\frac{300\,000}{500\,000} \times 100 = 60\%

The current ratio of 2.0 and quick ratio of 1.2 both exceed 1, so short-term solvency is sound even without relying on inventory. With 60 per cent of assets funded by owners and debt at two-thirds of equity, gearing is moderate, leaving the business reasonably stable while still using some borrowings.