Liquidity ratios

Common liquidity ratios include the current ratio, the quick ratio and the operating cash flow ratio. Different analysts consider different assets to be relevant in calculating liquidity. Some analysts will calculate only the sum of cash and equivalents divided by current liabilities because they feel that they are the most liquid assets, and would be the most likely to be used to cover short-term debts in an emergency. A company's ability to turn short-term assets into cash to cover debts is of the utmost importance when creditors are seeking payment. Bankruptcy analysts and mortgage originators frequently use the liquidity ratios to determine whether a company will be able to continue as a going concern.

1- Current ratio
The ratio is mainly used to give an idea of the company's ability to pay back its shortterm liabilities (debt and payables) with its short-term assets (cash, inventory, receivables). The higher the current ratio, the more capable the company is of paying its obligations. A ratio under 1 suggests that the company would be unable to pay off its obligations if they came due at that point. While this shows the company is not in good financial health, it does not necessarily mean that it will go bankrupt - as there are many ways to access financing - but it is definitely not a good sign. The current ratio can give a sense of the efficiency of a company's operating cycle or its ability to turn its product into cash. Companies that have trouble getting paid on their receivables or have long inventory turnover can run into liquidity problems because they are unable to alleviate their obligations. Because business operations differ in each industry, it is always more useful to compare companies within the same industry. This ratio is similar to the acid-test ratio except that the acid-test ratio does not include inventory and prepaids as assets that can be liquidated. The components of current ratio (current assets and current liabilities) can be used to derive working capital (difference between current assets and current liabilities). Working capital is frequently used to derive the working capital ratio, which is working capital as a ratio of sales.

2- Quick ratio
An indicator of a company's short-term liquidity. The quick ratio measures a company's ability to meet its short-term obligations with its most liquid assets. The higher the quick ratio, the better the position of the company. The quick ratio is calculated as: Quick Ratio = (Current Assets - Inventories) / Current Liabilities Also known as the "acid-test ratio" or the "quick assets ratio".

It indicates what proportion of equity and debt the company is using to finance its assets. assets and interest expenses. However. This can result in volatile earnings as a result of the additional interest expense. 2. 3-debt equity ratio A measure of a company's financial leverage calculated by dividing its total liabilities by stockholders' equity. If a lot of debt is used to finance increased operations (high debt to equity). For example. In the event that short-term obligations need to be paid off immediately. if a company has $10M in debt and $20M in equity. Also known as the Personal Debt/Equity Ratio. because it excludes inventory from current assets. A high debt/equity ratio generally means that a company has been aggressive in financing its growth with debt. the mix will differ. equity. the cost of this debt financing may outweigh the return that the company generates on the debt . but the main factors looked at include debt. depending on the company and the industry. A ratio used to measure a company's mix of operating costs. there are situations in which the current ratio would overestimate a company's short-term financial strength. There are several different ratios. Note: Sometimes only interest-bearing. Any ratio used to calculate the financial leverage of a company to get an idea of the company's methods of financing or to measure its ability to meet financial obligations.5 ($10M/$20M). a more well-known liquidity measure. The most well known financial leverage ratio is the debt-to-equity ratio. Fixed and variable costs are the two types of operating costs. this ratio can be applied to personal financial statements as well as corporate ones. then the shareholders benefit as more earnings are being spread among the same amount of shareholders. long-term debt is used instead of total liabilities in the calculation. the company could potentially generate more earnings than it would have without this outside financing. Leverage ratios 1. If this were to increase earnings by a greater amount than the debt cost (interest). it has a debt-to-equity ratio of 0. giving an idea of how changes in output will affect operating income.The quick ratio is more conservative than the current ratio. Inventory is excluded because some companies have difficulty turning their inventory into cash.

. Generally speaking. as compared to the firm's total debt obligations. Such ratios are frequently used when performing fundamental analysis on different companies. 4-Solvancy ratios One of many ratios used to measure a company's ability to meet long-term obligations. Activity ratios are used to measure the relative efficiency of a firm based on its use of its assets. leverage or other such balance sheet items. while personal computer companies have a debt/equity of under 0. cash.through investment and business activities and become too much for the company to handle. The solvency ratio measures the size of a company's after-tax income. The total assets turnover ratio and inventory turnover ratio are two popular examples of activity ratios used widely across most industries. the greater the probability that the company will default on its debt obligations. which would leave shareholders with nothing. capital- intensive industries such as auto manufacturing tend to have a debt/equity ratio above 2. For example. Activity ratio Accounting ratios that measure a firm's ability to convert different accounts within its balance sheets into cash or sales. the lower a company's solvency ratio. It provides a measurement of how likely a company will be to continue meeting its debt obligations. This can lead to bankruptcy.5. a solvency ratio of greater than 20% is considered financially healthy. Investopedia explains 'Activity Ratios' Companies will typically try to turn their production into cash or sales as fast as possible because this will generally lead to higher revenues. The measure is usually calculated as follows: Acceptable solvency ratios will vary from industry to industry. etc. but as a general rule of thumb. excluding non-cash depreciation expenses. The debt/equity ratio also depends on the industry in which the company operates. from its resources. These ratios are important in determining whether a company's management is doing a good enough job of generating revenues.

The receivables turnover ratio is an activity ratio. measuring how efficiently a firm uses its assets. .Receivables Turnover Ratio An accounting measure used to quantify a firm's effectiveness in extending credit as well as collecting debts. Accounts payable turnover ratio is calculated by taking the total purchases made from suppliers and dividing it by the average accounts payable amount during the same period.5. Formula: Some companies' reports will only show sales ." 6. 7- Accounts Payable Turnover Ratio A short-term liquidity measure used to quantify the rate at which a company pays off its suppliers.this can affect the ratio depending on the size of cash sales.Inventory turnover ratio A ratio showing how many times a company's inventory is sold and replaced over a period. The days in the period can then be divided by the inventory turnover formula to calculate the days it takes to sell the inventory on hand or "inventory turnover days.

specifically property. When used in fundamental analysis. the better because it means that the company is generating a lot of sales compared to the money it uses to fund the sales. if a company has current assets of $10 million and current liabilities of $9 million. return on assets and return on equity. prudent investors watch this ratio in following years to see how effective the investment in the fixed assets was. A higher fixed-asset turnover ratio shows that the company has been more effective in using the investment in fixed assets to generate revenues. The working capital turnover ratio is used to analyze the relationship between the money used to fund operations and the sales generated from these operations. It is important to note that a little bit of background knowledge is necessary in order to make .current liabilities) to fund operations and purchase inventory. When companies make these large purchases.net of depreciation. ome examples of profitability ratios are profit margin. These operations and inventory are then converted into sales revenue for the company. 9- Fixed-Asset Turnover Ratio A financial ratio of net sales to fixed assets.8- Working Capital Turnover A measurement comparing the depletion of working capital to the generation of sales over a given period. When compared to sales of $15 million. This provides some useful information as to how effectively a company is using its working capital to generate sales. where major purchases are made for PP&E to help increase output. this ratio can be compared to that of similar companies or to the company's own historical working capital turnovers. plant and equipment (PP&E) . The fixed-asset turnover ratio is calculated as: This ratio is often used as a measure in manufacturing industries. the working capital turnover ratio for the period is 15 ($15M/$1M). A company uses working capital (current assets . The fixed-asset turnover ratio measures a company's ability to generate net sales from fixed-asset investments . the higher the working capital turnover. Profitability Ratios A class of financial metrics that are used to assess a business's ability to generate earnings as compared to its expenses and other relevant costs incurred during a specific period of time. having a higher value relative to a competitor's ratio or the same ratio from a previous period is indicative that the company is doing well. its working capital is $1 million. For most of these ratios. In a general sense. For example.

Another variation is to present the balance sheet as of the end of each month for the past 12 months on a rolling basis. comparing a retailer's fourth-quarter profit margin with the profit margin from the same period a year before would be far more informative. liabilities. In both cases. which is useful for developing trend line analyses (though this works better when the reader has the entire set of financial statements to work with and not just the balance sheet). the intent is to provide the reader with a series of snapshots of a company's financial condition over a period of time. it would not be too useful to compare a retailer's fourth-quarter profit margin with its first-quarter profit margin. . typically experiences higher revenues and earnings for the Christmas season. For example. For instances. For example. Therefore. a comparative balance sheet could present the balance sheet as of the end of each year for the past three years. and 2010 13- Common Size Balance Sheet A company balance sheet that displays all items as percentages of a common base figure.relevant comparisons when analyzing these ratios. 2011. This type of financial statement can be used to allow for easy analysis between companies or between time periods of a company 14- Comparative Balance Sheet A comparative balance sheet presents side-by-side information about an entity's assets. On the other hand. 10- gross Loss Ratio net loss ratios 11- 12- comparative income statement A comparative income statement will consist of two or three columns of amounts appearing to the right of the account titles or descriptions. some industries experience seasonality in their operations. the income statement for the year 2012 will report the amounts for each of the years 2012. and shareholders' equity as of multiple points in time. The retail industry. for example.

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