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Опубликовано в Binary options in germany | Октябрь 2, 2012

Liquidity ratios focus on a firm's ability to pay its short-term debt obligations. The information you need to calculate these ratios can be. What is a Liquidity Ratio? A liquidity ratio is. Quick Ratio - A firm's cash or near cash current assets divided by its total current liabilities. It shows the ability of a firm to quickly meet its current.
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Short-term Liquidity Ratios - Financial Statement Analysis
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Liquidity Ratios - Current Ratio and Quick Ratio (Acid Test Ratio)
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Days sales outstanding , or DSO, refers to the average number of days it takes a company to collect payment after it makes a sale. A higher DSO means that a company is taking unduly long to collect payment and is tying up capital in receivables. DSOs are generally calculated quarterly or annually. A solvent company is one that owns more than it owes; in other words, it has a positive net worth and a manageable debt load.

While liquidity ratios focus on a firm's ability to meet short-term obligations, solvency ratios consider a company's long-term financial wellbeing. Here are some of the most popular solvency ratios. A rising debt-to-equity ratio implies higher interest expenses, and beyond a certain point, it may affect a company's credit rating , making it more expensive to raise more debt.

Another leverage measure, the debt-to-assets ratio measures the percentage of a company's assets that have been financed with debt short-term and long-term. A higher ratio indicates a greater degree of leverage, and consequently, financial risk. The interest coverage ratio measures the company's ability to meet the interest expense on its debt, which is equivalent to its earnings before interest and taxes EBIT. The higher the ratio, the better the company's ability to cover its interest expense.

There are key points that should be considered when using solvency and liquidity ratios. This includes using both sets of ratios—liquidity and solvency—to get the complete picture of a company's financial health; making this assessment on the basis of just one set of ratios may provide a misleading depiction of its finances.

As well, it's necessary to compare apples to apples. These ratios vary widely from industry to industry. A comparison of financial ratios for two or more companies would only be meaningful if they operate in the same industry. Finally, it's necessary to evaluate trends. Analyzing the trend of these ratios over time will enable you to see if the company's position is improving or deteriorating.

Pay particular attention to negative outliers to check if they are the result of a one-time event or indicate a worsening of the company's fundamentals. Solvency and liquidity are equally important, and healthy companies are both solvent and possess adequate liquidity. A number of liquidity ratios and solvency ratios are used to measure a company's financial health, the most common of which are discussed below. Let's use some of these liquidity and solvency ratios to demonstrate their effectiveness in assessing a company's financial condition.

Consider two hypothetical companies, Liquids Inc. We assume that both companies operate in the same manufacturing sector, i. Since both companies are assumed to have only long-term debt, this is the only debt included in the solvency ratios shown below.

If they did have short-term debt which would show up in current liabilities , this would be added to long-term debt when computing the solvency ratios. We can draw a number of conclusions about the financial condition of these two companies from these ratios. Liquids Inc. However, financial leverage based on its solvency ratios appears quite high.

Debt exceeds equity by more than three times, while two-thirds of assets have been financed by debt. Note, as well, that close to half of non-current assets consist of intangible assets such as goodwill and patents. To summarize, Liquids Inc. Solvents Co. The company's current ratio of 0. Even better, the company's asset base consists wholly of tangible assets, which means that Solvents Co. Overall, Solvents Co. A liquidity crisis can arise even at healthy companies if circumstances come about that make it difficult for them to meet short-term obligations such as repaying their loans and paying their employees.

The best example of such a far-reaching liquidity catastrophe in recent memory is the global credit crunch of — Commercial paper—short-term debt that is issued by large companies to finance current assets and pay off current liabilities—played a central role in this financial crisis. But unless the financial system is in a credit crunch, a company-specific liquidity crisis can be resolved relatively easily with a liquidity injection, as long as the company is solvent. This is because the company can pledge some assets if it is required to raise cash to tide over the liquidity squeeze.

This route may not be available for a company that is technically insolvent since a liquidity crisis would exacerbate its financial situation and force it into bankruptcy. Insolvency, however, indicates a more serious underlying problem that generally takes longer to work out, and it may necessitate major changes and radical restructuring of a company's operations. Management of a company faced with an insolvency will have to make tough decisions to reduce debt, such as closing plants, selling off assets, and laying off employees.

Going back to the earlier example, although Solvents Co. Federal Reserve Bank of St. Financial Statements. Financial Ratios. Your Money. Key Performance Indicators. The Interpretation of Financial Statements. Liquidity ratios are measurements used to examine the ability of an organization to pay off its short-term obligations. Liquidity ratios are commonly used by prospective creditors and lenders to decide whether to extend credit or debt, respectively, to companies.

These ratios compare various combinations of relatively liquid assets to the amount of current liabilities stated on an organization's most recent balance sheet. The higher the ratio, the better the ability of a firm of pay off its obligations in a timely manner.

A possible concern with using liquidity ratios is that the current liabilities of a business may not be coming due for payment on the same dates when the offsetting current assets can be liquidated, so even a robust liquidity ratio can mask a potential cash shortfall.

Another concern is that these ratios do not take into account the ability of a business to borrow money; a large line of credit will counteract a low liquidity ratio. The current ratio compares current assets to current liabilities. The intent behind using it is to see if there are sufficient current assets on hand to pay for current liabilities, if the current assets were to be liquidated.

Its main flaw is that it includes inventory as a current asset. Inventory may not be that easy to convert into cash, and so may not be a good indicator of liquidity. The quick ratio is the same as the current ratio, but excludes inventory. Consequently, most remaining assets should be readily convertible into cash within a short period of time.

This is perhaps the best liquidity ratio for evaluating whether a business has sufficient short-term assets on hand to meet its current obligations. The cash ratio compares just cash and readily convertible investments to current liabilities.

If it results in a negative amount, it means that current assets are not sufficient to cover for current liabilities. The net working capital also shows how much excess or deficiency there is. The net working capital works as a "safety cushion" to creditors. Creditors want to know whether the company as enough current assets before extending new credit. A company has a better chance of acquiring credit if it maintains a good level of working capital.

The current ratio is equal to current assets divided by current liabilities. If current assets exceed current liabilities, the current ratio will result in a value that is greater than 1; otherwise, less than 1. Generally, a value greater than 1 is a favorable sign. It means that the company can meet its current liabilities with its current assets.

The value of the current ratio shows how much current assets the company has for every current liability. For example, a current ratio of 1. The acid test-ratio or "quick ratio" measures the ability of a company to pay short-term liabilities using quick assets.

Quick assets refer to the more liquid types of current assets, i. Inventories and prepayments are excluded from the computation. The cash ratio is an even more stringent measure of liquidity as it considers cash and marketable securities only. It shows whether the company has readily available cash and marketable securities to pay for its current liabilities.

For example, by using only liquidity ratio to assess the liquidity problem in the company, the result of analysis seems not realistic because those ratios are the result of financial figure calculation which could be manipulated by management. The better way to make analysis is to include these groups of ratios with other financial and non-financial ratios. However, the following are the most use Liquidity Ratio:.

The most popular Liquidity Ratio that we normally see in any liquidity assessment and measurement. The Current Ratio is said to be good if it is better than one. And if it is less than one, it means that current liabilities are bigger than current assets. Quick Ratio is also the most popular liquidity ratio which we normally see in most of the assessment.

This ratio disregard inventories in its calculation on the basis that inventories need a bit long time to convert into cash. The calculation of this ratio is simple. We eliminate the inventories from current assets and then divide them with current liabilities. Cash Ratio is another liquidity ratio which is taken into account only cash, cash equivalent, and investment fund in the calculation and assessment.

The cash ratio is very similar to the Quick Ratio. This ratio is concerning about Current Asset and Current Liabilities. Working Capital Ratio is calculated in the same way as Current Ratios. The main function of this ratio is to assess whether current assets could cover current liabilities or not.

Increasing current assets lead to an increased working capital ratio, and it is healthy when the ratio is higher than one. Sometimes we use interest expenses or sometimes we use interest charges. These two are the same thing.

If this ratio gets more than one, it means that the company generates enough profit to cover its interest charge. Yet, if this ratio is smaller than one, the company might need to find other funds to pay its interest charged. There are many reasons why the liquidity ratios are calculated and assess. The entity itself might want to assess its own liquidity ratios to ensure that the entity is not gonged to be rate down due to poor liquidity ratio by creditors, bankers, shareholders, and other related stakeholders.

These ratios mostly assess by banks, creditors, and investors as part of their analysis.

We assume that both companies operate in the same manufacturing sector i. Note that in our example, we will assume that current liabilities only consist of accounts payable and other liabilities, with no short-term debt. We can draw several conclusions about the financial condition of these two companies from these ratios.

Liquids, Inc. However, financial leverage based on its solvency ratios appears quite high. Debt exceeds equity by more than three times, while two-thirds of assets have been financed by debt. Note as well that close to half of non-current assets consist of intangible assets such as goodwill and patents. To summarize, Liquids, Inc.

Solvents, Co. The company's current ratio of 0. Even better, the company's asset base consists wholly of tangible assets, which means that Solvents, Co. Overall, Solvents, Co. Liquidity refers to how easily or efficiently cash can be obtained to pay bills and other short-term obligations. Assets that can be readily sold, like stocks and bonds, are also considered to be liquid although cash is, of course, the most liquid asset of all.

Businesses need enough liquidity on hand to cover their bills and obligations so that they can pay vendors, keep up with payroll, and keep their operations going day-in and day out. Liquidity refers to the ability to cover short-term obligations. Solvency, on the other hand, is a firm's ability to pay long-term obligations. For a firm, this will often include being able to repay interest and principal on debts such as bonds or long-term leases.

Fundamentally, all liquidity ratios measure a firm's ability to cover short-term obligations by dividing current assets by current liabilities CL. The cash ratio looks at only the cash on hand divided by CL, while the quick ratio adds in cash equivalents like money market holdings as well as marketable securities and accounts receivable. The current ratio includes all current assets. In this case, a liquidity crisis can arise even at healthy companies—if circumstances arise that make it difficult to meet short-term obligations, such as repaying their loans and paying their employees or suppliers.

One example of a far-reaching liquidity crisis from recent history is the global credit crunch of , where many companies found themselves unable to secure short-term financing to pay their immediate obligations. Federal Reserve Bank of New York. Accessed Aug. Financial Ratios. Financial Statements. Your Money. Personal Finance. Your Practice.

Popular Courses. Table of Contents Expand. Table of Contents. What Are Liquidity Ratios? Understanding Liquidity Ratios. Types of Liquidity Ratios. Special Considerations. Solvency Ratios vs. Liquidity Ratios. Examples Using Liquidity Ratios. Part of. Guide to Financial Ratios.

Part Of. Overview of Financial Ratios. Profitability Ratios. Solvency Ratios. Valuation Ratios. Key Takeaways Liquidity ratios are an important class of financial metrics used to determine a debtor's ability to pay off current debt obligations without raising external capital. Common liquidity ratios include the quick ratio, current ratio, and days sales outstanding.

Liquidity ratios determine a company's ability to cover short-term obligations and cash flows, while solvency ratios are concerned with a longer-term ability to pay ongoing debts. Balance Sheets for Liquids Inc.

Solvents Co. Article Sources. Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. Quick assets refer to the more liquid types of current assets, i. Inventories and prepayments are excluded from the computation.

The cash ratio is an even more stringent measure of liquidity as it considers cash and marketable securities only. It shows whether the company has readily available cash and marketable securities to pay for its current liabilities. The above ratios measure the ability of a company to pay short-term obligations. They measure whether the company has enough current assets or specific current assets to meet current liabilities.

These ratios provide an even useful insight when compared to benchmarks, such as past performance and industry averages. Liquidity ratios measure the ability of a company to meet short-term liabilities using short-term assets. More under Financial Statement Analysis.

Financial Ratios. Liquidity ratios. Liquidity ratios Gross Profit Margin. Profitability Ratios. Financial Statement Analysis. More under Financial Statement Analysis 1.