The Importance Of Liquidity Ratios

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Liquidity Ratios are very important for the potential vendor of a company as it measures the ability of a supplier to meet its short-term obligations (Ready Ratios, 2016). In other words, the liquidity ratios show the solvency of a company in terms of its assets versus liabilities. One of the most important liquidity ratio for vendors is the current ratio. Current ratio calculates a company’s ability to convert its assets to cash in order to pay its liabilities if they become due within twelve months (Kennon, 2016). The current ratio varies by industry as each industry has different economic needs, cash conversion cycles and funding practices (Kennon, 2016). Most suppliers conduct their business on vendor financing and they set out a time period …show more content…
The quick ratio which is also called acid-test ratio is different from the current ratio as it excludes some current assets as they cannot convert into cash quickly such as inventory. The ratio informs potential vendors if a company will be able to repay their debt on time based on the most liquid assets such as cash and marketable securities (Accounting Coach, 2016).
Profitability ratios are also important for vendors to know if the company is successful enough to stay in business longer. These profitability ratios include; the Return on Assets to show how the business is using its assets to generate profits, Return on Equity to assess the return on investment, gross profit margin to evaluate how the company covers its overhead costs and net profit margin to calculates the company’s earnings (Kennon,
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This ratio measures the percentage of a company’s net income to its sales revenue. The investors should ensure that the gross profit margin of a company remain stable over time as significant fluctuations show a negative sign such as fraud or a positive sign such as improvement or an expansion (Kennon, 2016).
Interest coverage ratio also known as times interest earned (TIE) is used to measure a company’s readiness to meet its interest payment obligations. It calculates the number of time a company is able to make the interest payments on its debt (Kennon, 2016). The higher the ratio, the better the company’s liquidity and less chance to bankruptcy.
Other important ratios for investors are Price to Earnings ratio (P/E ratio) and Debt to Equity ratio.P/E ratio indicates how much money an investor is willing to pay to acquire one $1 of a company’s earnings or evaluating the demand of a company’s stock. The P/E ratio also help the investors to compare the company in the same industry and to determine if the company is overpriced or underpriced (Kennon, 2016). Debt to equity ratio is a leverage ratio which evaluates a company’s long term debt paying ability. This ratio measures the degree of protection to creditors and investors in case of insolvency. The lower the ratio, the better is the company’s position (Kennon,

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