Essay on Ratio Analysis : Liquidity Ratios

1643 Words May 24th, 2016 7 Pages
Liquidity Ratios Current Ratio measures the ability of a firm to meet its short-term (usually up to 1 year) obligations. It is a measure of Liquidity. The higher your Current Ratio is, the greater your short-term solvency. Although there are several ratios which indicate the liquidity of a company, the Current Ratio can provide us with all the information we need. To be really useful we must compare it over at least three years.
The Current Ratio is the ratio of total Current Assets to total Current Liabilities.
Current Ratio = Current Assets / Current Liabilities
Current assets include cash and bank balances; inventory of raw materials, work-in-process, and finished goods; marketable securities; borrowers (net of provision for bad and doubtful debts); bills receivable; and prepaid expenses.
Current liabilities consist of accounts payable, current portion of long-term debt, accrued salaries, and accrued taxes.
When interpreting Current Ratio, you can’t ignore Asset Quality. A high proportion of current assets in the form of cash and receivables are more liquid than one with a high proportion in the form of inventories, even though both companies have the same current ratio. A current ratio of 2:1 is considered satisfactory. An excellent indicator of asset quality is the Quick Ratio
Quick ratio or Acid Test is the ratio of cash and cash equivalents, marketable securities, and accounts receivable to…

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