Liquidity ratios

Liquidity ratios

A liquidity ratio is a useful tool to determine the company short term financing position. The higher the value indicates company better liquidity position in other words company assets are valuable and can easily converted into cash.   Most common liquidity ratios are current ration quick ratio.

 

Current Ratio –                Current Assets/current Liabilities

 The current ratio derives the results for company current assets divided by current liabilities. Current ration is helpful to find out the company liquidity position; creditors always look for this information before giving out the loan to the company. Lower the value of current ratio, higher the risk for creditors as well as for the company.

 

OR

Current Ration is Current Assets(Short Term Assets) divided by Current Liabilities(short term liabilities). It is used to determine if a company can pays its short term obligations with its current assets. The current ratio is another test of a company’s financial strength. It calculates how many dollars in assets are likely to be converted to cash within one year in order to pay debts that come due during the same year.

Quick Ration-              Current assets – Inventory/Current Liabilities

 Quick ratio will more clear the picture most of the time companies have bulk of inventories in their warehouse, in this case current asset ration not generate the proper results. Quick ratio is used to cross check, more difference in current and quick ration indicates that company sales is slow and inventory level is too high. Higher the value of quick ratio, better the company liquidity position. One thing is most important to note that quick ration is always lower than current ration.

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