FINANCIAL RATIOS

LIQUIDITY RATIO 

This is a financial ratio that uses information contained in the financial statement of a
company to evaluate its ability pay its current liabilities as at when due. Examples of
liquidity ratios include:

a.   CURRENT RATIO/Working capital: It is obtained by dividing current assets by

current liabilities. =      Current assets / current liability.

If the result of the analysis returns 1, then it is at the middle ground. However, if it is less
than 1, then it is risky – the firm will have to pay off some debt before seeking for
additional liabilities. It is safer to have a result that is above 1.

b.   QUICK RATIO: This calculates the company’s ability to meet current liabilities using
quick assets only. Quick assets are current assets that can be converted to cash within 90
days or in a very short-term. Example includes: Cash and equivalents, current accounts
receivable, short-term investments or marketable securities etc. = current assets –
inventory – prepaid expenses/current liabilities

c.   Other Liquidity Ratios include: 1. Cash to equity Ratio = cash & cash

equivalents/current liabilities 2. Interest Coverage Ratio = EBIT/Interest Expense

These Liquidity ratios tell us about a company’s ability to meet its short-term financial
obligations. Potentially, these ratios show the cash levels of a company and the ability to
turn other assets into cash to pay off liabilities and other current obligations.

Liquidity is not only a measure of how much cash a business has. It is also a measure of
how easy it will be for the company to raise enough cash or convert assets into cash.
Assets like accounts receivable, trading securities, and inventory are relatively easy for
many companies to convert into cash in the short term. 

This ratio helps Banks and other creditors to evaluate the capability of borrowers to meet
their repayment obligation.