Liquidity Ratios

10 Key excerpts on "Liquidity Ratios"

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  Hospitality Management Accounting

  • Martin G. Jagels(Author)
  • 2006(Publication Date)
  • Wiley

    (Publisher)

  This is to be expected be- cause each group interprets the ratio from a different perspective. RATIO CATEGORIES Ratio analysis will be discussed in the following five major categories using in- formation from Exhibit 4.1, annual balance sheets for Years 0006 and 0007, and Exhibit 4.2, condensed income statement for the year ended December 31, 0007: 1. Current Liquidity Ratios. The primary purpose of Liquidity Ratios is to iden- tify the relationship between current assets and current liabilities; thus, liq- uidity ratios provide the basis for an evaluation of the ability of a company to meet its current obligations. Liquidity Ratios that provide a direct analysis of current and quick assets in relation to current liabilities are the current ratio (or the working capital ratio) and the quick ratio (or acid test ratio). The analysis of credit sales revenue provides an analysis of the average time that elapses between the creation and collection of current receivables. Typi- cal ratios concerning receivables are the credit card receivables turnover; credit card receivables as a percentage of net credit sales; credit cards average col- lection period; accounts receivable turnover; accounts receivable as a per- centage of net credit sales; and accounts receivable average collection period. 2. Profitability ratios. Resources and assets are made available to management to conduct sales-revenue-generating operations, and the profitability ratios show management’s effectiveness in using the resources (assets) during operating pe- riods. Profitability ratios to be discussed are return on assets, profit to sales ra- tio, return on ownership equity, return on total investment, and earnings per share. 3. Long-term solvency ratios. These ratios are also called net worth ratios, and they measure a company’s ability to meet its long-term debt repayment re- sponsibilities.

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  Financial Analysis with Microsoft Excel

  • Timothy Mayes(Author)
  • 2020(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  These ratios are also known as debt management ratios. 4. Coverage ratios are similar to Liquidity Ratios in that they describe the ability of a firm to pay certain expenses. 5. Profitability ratios provide indications of how profitable a firm has been over a period of time. One additional category, relative value ratios, will be discussed in Chapter 9 on page 292. Before we begin the discussion of individual financial ratios, open your Elvis Products International workbook from Chapter 2, and add a new worksheet named “Ratios.” Liquidity Ratios The term “liquidity” refers to the speed with which an asset can be converted into cash without large discounts to its value. Some assets, such as accounts receivable, can easily be converted into cash with only small discounts. Other assets, such as buildings, can be converted into cash very quickly only if large price concessions are given. We, therefore, say that accounts receivable are more liquid than buildings. All other things being equal, a firm with more liquid assets will be more able to meet its maturing obligations (e.g., its accounts payable and other short-term debts) than Copyright 2021 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Liquidity Ratios 77 a firm with fewer liquid assets. As you might imagine, creditors are particularly con- cerned with a firm’s ability to pay its bills. To assess this ability, it is common to use the current ratio and/or the quick ratio.

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  Financial Accounting For Dummies

  • Maire Loughran(Author)
  • 2020(Publication Date)
  • For Dummies

    (Publisher)

  Trend analysis isn’t normally applicable to liquidity measurements because when it comes to liquidity, financial statement users are looking at what’s going on in the short term — not over a long period of time. Your financial accounting textbook discusses three principal evaluations to mea -sure liquidity: current ratio, acid-test ratio, and working capital. The first two show up in the form of (you guessed it!) ratios. You express working capital as a dollar amount. These measurements are all easier to understand if you use account balances to work through them, so let’s get to work computing some figures! Figuring the current ratio You find a company’s current ratio by dividing its current assets by its current liabilities. I discuss current assets in Chapter 7 and current liabilities in Chapter 8, but here are some quick examples of each: » Current assets: Accounts such as cash, accounts receivable, merchandise inventory, and short-term investments » Current liabilities: Accounts payable and all other debt that is due within 12 months of the balance sheet date, such as accrued payroll, which is wages employees have earned but not yet been paid So, let’s say you are looking at a balance sheet. A company’s current assets are $120,000, and its current liabilities are $57,000. The current ratio is 2.1 ($120,000 divided by $57,000). The current ratio tells you a lot about how liquid a company is because current assets are either cash or are easily converted to cash in the short term; in theory, they can be used to pay the short-term obligations. Being able to meet short-term obligations is crucial to a company remaining a going concern. The theory behind the current ratio is pretty darn simple, so if your financial accounting instructor is anything like me, she is going to test your understanding of the current ratio by giving you facts and having you back into a figure for cur -rent assets or current liabilities.

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  Financial Analysis in Hong Kong

  Qualitative Examination of Financial Statements for CEOs and Board Members (Second Edition)

  • Benny K. B. Kwok(Author)
  • 2013(Publication Date)
  • The Chinese University of Hong Kong

    (Publisher)

  If so, any further analysis would seem irrelevant. A corporation is regarded as solvent when: • its assets exceed its total liabilities (i.e. it has a positive net worth); and • it can pay its debts when they fall due. Solvency may be viewed in two time frames: • Could the corporation pay all its short-term liabilities when they fall 4. Accounting Ratios 71 due (i.e. Liquidity Ratios)? • Will the corporation be able to meet its long-term obligations (i.e. leverage or gearing ratios which are considered in the subsequent section)? Short-term solvency analysis is especially important to lenders, suppliers, employees, regulators and those who are concerned with the ability to meet demands for cash in the near future. Bear in mind that it is often insolvent businesses rather than unprofitable ones that go into liquidation. Liquidity Ratios answer questions of whether a corporation pays its debts when they fall due and measure the short-term solvency of a corporation, i.e. its ability to continue in the short term by paying its current obligations. They may include ratios that measure the efficiency of the usage of current assets and current liabilities. Current Ratio In considering short-term solvency, analysts try to see if the corporation can meet all its short-term debts. Analysts need to look at the statement of financial position and the relationship between current assets and current liabilities. In other words, the current ratio compares the corporation’s assets which can be realized within a year with the liabilities it has to repay in the next year. In general, the higher the current ratio, the more liquid the corporation is. The current ratio is represented by: Current Ratio = Current Assets Current Liabilities Following on from AAC’s 2011 annual report, the current ratio for 2011 and 2010 are 1.82 times (= 3,425,305 / 1,887,066) and 2.42 times (= 3,402,371 / 1,407,928) respectively.

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  Managing Financial Resources

  • Michael Broadbent, John M. Cullen(Authors)
  • 2014(Publication Date)
  • Butterworth-Heinemann

    (Publisher)

  There are two major ratios which are significant in measuring the all-important liquidity of a business, they are: 1 The current ratio 2 The acid test (or quick) ratio Both can be calculated from balance sheet figures. The current ratio is the ratio of current assets to current liabilities, expressed as follows: Current assets Current liabilities Assessment of company performance 53 Zeda has current assets of £283m (£241m) and current liabilities of £196m (£169m), giving a current ratio of 1.44 (1.43). This means that if all short-term creditors demand their money immediately then their claims could be met 1.44 times (1.43 times) if the current assets could be converted into cash immediately. While this is clearly unreasonable it does give an indication of liquidity, because under normal trading circumstances short-term creditors are unlikely to demand immediate payment. Accounting textbooks often state that a current ratio of 2.1 is adequate, but such generalizations are not useful, as highly efficient businesses may be able to reduce stocks, by applying just-in-time techniques, and reduce debtors by cash trading without affecting financial stability. The acid test ratio gives a better measure of liquidity as it eliminates stock, the least liquid asset (that is, the most difficult to convert into cash quickly) from the current ratio, so providing a measure of the most liquid assets against short-term claims. The ratio is expressed as follows: Current assets -stocks Current liabilities Zeda has current assets of £283m (£241m) which includes stocks of £166m (£137m), giving an acid test ratio of 0.60 (0.62). Zeda is a very large retail company and clearly has the ability to trade with what would be considered to be a weak acid test ratio, this is because its sales income is mainly in cash, while its creditors are supplying goods in credit terms. Accounting text books claim an acid test ratio of 1.1 to be ideal, but again this varies from industry to industry.

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  The Meaning of Company Accounts

  • Walter Reid, D R Myddelton(Authors)
  • 2017(Publication Date)
  • Routledge

    (Publisher)

  FINANCIAL STATUS RATIOS Ratios of financial status measure a company’s ability to meet its liabilities. They can be divided between: Solvency ratios – dealing with long-term liabilities. Liquidity Ratios – dealing with short-term liabilities. Please refer again to the 2005 accounts of Precision Locks Limited (opposite, left) and calculate the following financial status ratios. Then turn to the next page, and compare your answers with the ratios shown there. As you calculate the ratios, consider what they mean and how they contribute to your appraisal of the company’s financial status. SOLVENCY RATIOS 2005 2004 Debt ratio Debt = = 20.0% Capital employed Interest cover Profit before interest and tax = = 7.0 times Loan interest Liquidity Ratios Current ratio Current assets = = 2.5 times Current liabilities Acid test Liquid assets (debtors + cash) = = 1.05 times Current liabilities 43 SOLVENCY RATIOS Debt Debt 100 Debt ratio: = = = 18.2% Capital employed Debt + Equity 550 Debt is 18 per cent of the capital employed, which means (in this simple case) that equity is the other 82 per cent. This relatively low debt ratio (‘gearing’) gives lenders a fairly high level of safety (‘equity cushion’). Another way of measuring the same thing is the ‘debt/equity’ ratio: Debt Debt 100 = = = 22.2% Shareholders’ funds Equity 450 Both these gearing ratios are common, so it is important not to confuse them. Bank overdrafts are legally repayable ‘on demand’, and appear under ‘Creditors due within one year’. But both bank overdrafts and any current portions of long-term debt represent negotiated interest-bearing finance. They may best be regarded as part of a company’s interest-bearing capital employed. They contrast with ‘spontaneous’ sources of funds, normally not bearing interest, such as trade credit or tax payable. The net debt ratio uses ‘debt less cash’, in this case 100 – 40 = 60.

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  Value-Based Working Capital Management

  Determining Liquid Asset Levels in Entrepreneurial Environments

  • G. Michalski(Author)
  • 2014(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  The different methods of measuring liquidity can be divided into two groups: static and dynamic. The former are those that use data from the moment at which the level of enterprise liquidity is determined, thus, in principle, from the present and the past. The dynamic methods of measuring, in turn, are based on forecast data (Nowak 1995, pp. 49–53; Sierpinska and Wedzki 1997, pp. 35–36). First, we will deal with so-called traditional measurements of liquidity. They are based on the data received directly from the financial statements, most often from the balance sheet. Such measurements are constructed in such a way as to guarantee independence of the measurement results regardless of the size of the enterprise and can be used for comparing many different types of entities. Therefore, they allow for comparison of the liquidity between enterprises. Their design allows one also to observe changes in liquidity over time in one enterprise even if its dimensions change.

  Current liquidity ratio is the ratio of current assets to current liabilities (Henderson and Maness 1989, p. 100).

  where WBP =  current ratio, CA =  the level of current assets, and CL =  the level of current liabilities (obligations due soon).

  Figure 2.1 and Table 2.1 illustrate the levels of current Liquidity Ratios before (2004−06), during (2007−09), and after (2010–12) the crisis in Czech (CZ), Polish (PL), Slovak (SL), Lithuanian (LT), Latvian (LV), Estonian (EE), Bosnian and Herzegovinian (BA), Hungarian (HU), Ukrainian (UA), Serbian (RS), and Bulgarian (BG) manufacturing enterprises.

  Figure 2.1   Central European current ratio (WBP) levels before (2003–06), during (2007–09), and after (2010–2012) the crisis in a business environment with continuous growing risk sensitivity

  Source: Own study based on Database Amadeus product of Bureau van Dijk (date of release: 2013 SEP 10).

  Table 2.1   Central European current ratio (WBP) levels before (2003–06), during (2007–09), and after(2010–2012) the crisis in a business environment with continuous growing risk sensitivity

  As presented in Table 2.1 and Figure 2.1 , the crisis is strongly connected with the average current ratio levels. That observation goes against traditional thinking about liquidity levels that claim that liquidity is smaller during and after a crisis. But this is in accordance with my claim in the previous chapter that growing risk sensitivity forces business managers to collect higher working capital levels to hedge against risk during and after crisis conditions. We also claimed that such a level could be a used as an alarm to warn decision makers about a coming crisis. In the period before a crisis, such current ratio levels start to grow. Such growth accords with the expectation that before the crisis the managers intuitively respond to higher risk sensitivity, making decisions that result in higher levels of both working capital and liquid assets. This is also linked with the intrinsic value of enterprise liquidity

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  Financial Intelligence for IT Professionals

  What You Really Need to Know About the Numbers

  • Karen Berman, Joe Knight, John Case(Authors)
  • 2008(Publication Date)
  • Harvard Business Review Press

    (Publisher)

  airline industry and others. Rather than buying equipment such as an air-plane outright, a company leases it from an investor. The lease payments count as an expense on the income statement, but there is no asset and no debt related to that asset on the company’s books. Some companies that are already overleveraged are willing to pay a premium to lease equipment just to keep these two ratios in the area that bankers and investors like to see. If you want to get a complete sense of your company’s indebtedness, by all means calculate the ratios—but ask someone in finance if the com-pany uses any debt-like instruments such as operating leases as well. 158 RATIOS 22 Liquidity Ratios Can We Pay Our Bills? L iquidity ratios tell you about a com-pany’s ability to meet all its financial obligations—not just debt, but pay-roll, payments to vendors, taxes, and so on. These ratios are particularly important to small businesses—the ones that are often in danger of run-ning out of cash—but they become important whenever a larger company encounters financial trouble as well. Not to harp on the airlines too much, but again they are a case in point. You can bet that in the years right after 2001, professional investors and bondholders were carefully watching the Liquidity Ratios of some of the larger airlines. Again, we’ll limit ourselves to two of the most common ratios. CURRENT RATIO The current ratio measures a company’s current assets against its current liabilities. Remember from the balance sheet chapters (part 3) that cur-rent in accountantese generally means a period of less than a year. So current assets are those that can be converted into cash in less than a year; the fig-ure normally includes accounts receivable and inventory as well as cash. Current liabilities are those that will have to be paid off in less than a year, mostly accounts payable and short-term loans.

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  Business Ratios and Formulas

  A Comprehensive Guide

  • Steven M. Bragg(Author)
  • 2003(Publication Date)
  • Wiley

    (Publisher)

  Within the one-month time frame, the company must pay $148,000, while its total current liabilities are $197,000. Using this information, the controller calculates the ratio as: Liquidity Measurements / 93 Current liabilities with required payment dates ——————————————————— = Total current liabilities $148,000 Current liabilities with required payment dates ———————————————————————— = $197,000 Total current liabilities 75% Required current liabilities to total current liabilities ratio Cautions: This ratio does not reveal a great deal of information if measured only for a single period, since there is no way to compare it to historical information. A bet- ter approach is to measure it on a trend line, or to compare it to the same period in the preceding year, when the liability proportion should have been about the same. Also, the ratio does not reveal how much cash is actually needed for short-term payment requirements, so it should be supplemented with a short-term cash forecast that itemizes the precise cash flows to be expected over the measurement period. WORKING CAPITAL TO DEBT RATIO Description: The working capital to debt ratio is used to see if a company could pay off its debt by liquidating its working capital. This measure is used only in cases where debt must be paid off at once, since the elimination of all working capital makes it impossible to run a business and will likely lead to its dissolution. Formula: Add up cash, accounts receivable, and inventory, and subtract all ac- counts payable from the sum. Then divide total debt into the result. A variation is to use only short-term debt in the denominator, on the grounds that only this por- tion of the debt will come due for payment.

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  Family Business by the Numbers

  How Financial Statements Impact Your Business

  • N. Schwarz(Author)
  • 2017(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  “I guess that tells us what percentage of our Current Liabilities is covered by our most liquid assets.” “They total 83%,” Greg added, “which doesn’t seem enough to pay bills without selling at least some Inventory.” “You’ve hit on our industry’s ideal,” Holmes replied, “a ratio of 1 to 1, or 100%. However, a ratio of 0.75 to 1, or 75%, is acceptable. As was the case with the Current Ratio, FerMon’s Quick Ratio figure is somewhat on the low side but falls within the acceptable parameters. Note that the Quick Ratio statistic also ignores the timing of receipts and payments.” “Since the Quick Ratio deals only with Cash and Receivables, our most liquid assets, isn’t the question of timing there less criti- cal?” Sue asked. “Good point,” Holmes commended her. “But we still have to consider timing, especially since we have already noted growing delays in the payment of Receivables.” FINANCIAL RATIOS AND ANALYSIS TOOLS 93 Industry Norms “You have mentioned ‘industry norms’ a couple of times,” Greg observed. “Do you mean that what is ‘good’ and ‘bad’ varies with the type of company?” “Absolutely,” Holmes replied. “For example, a company that services computers should have a lot less money tied up in inven- tory than an automobile dealer.” “But if there are no broad standards, how can one evaluate the financial-analysis figures in an annual report?” Sue asked. “That’s not always easy,” Holmes admitted. “You would start with the trade association and publications dedicated to a par- ticular industry. You could also access the Annual Statement Studies, available through RMA (the Risk Management Association) at www.rmahq.org for information on a number of industries.” Net Working Capital Greg scratched his head. “I’m a little confused by the term ‘Working Capital.’ I thought all the money invested in a company was working capital.” Holmes smiled.

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