Liquidity ratios

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Liquidity ratios

  1. 1. Liquidity Ratios<br />Current Ratio<br />Acid Test Ratio<br />
  2. 2. Current Ratio<br />Used to Discover if:<br />Current assets cover current liabilities or debts if a company needs to liquidate them (assets) in a hurry <br />ex. Going out of business<br />Current Assets<br />Current Liabilities<br />
  3. 3. Current Ratio Use<br />Good ratio = 2<br />Pay attention to industry norm<br />Important: Quality of current assets helps determine how quickly they can sell<br />
  4. 4. Asset Liquidity<br />= less liquid depending on who owes company what<br />= most liquid<br />Receivables<br />= somewhat liquid<br />= Not very liquid<br />Add up the Value<br />Inventory<br />Short-term Investments<br />= somewhat liquid<br />= Not Liquid<br />Stock<br />Office Building<br />
  5. 5. Current Ratio Use<br />Good ratio = 2<br />Pay attention to industry norm<br />Important: Quality of current assets determine how quickly they can sell<br />
  6. 6. Current Ratio Example<br />Metal Shop Balance Sheet<br />1997:<br />$5,310,900/$640,647= 8.23<br />1998:<br />$19,681,770/$817,692= 24.07<br />1999:<br />$58,654,548/$1,285,620= 45.62<br />Why so high?<br /><ul><li>Cash is most liquid asset</li></li></ul><li>Acid Test Ratio<br />Also Called Liquidity<br />Weakness of current ratio = inclusion of stock (inventory)<br />Used to discover if:<br />Current assets (without stock) cover current liabilities or debts if a company needs to liquidate them (assets) in a hurry<br />Current assets less stock<br />Current liabilities<br />
  7. 7. Acid Test Ratio Use<br />Good ratio = 1<br />Pay attention to industry norm<br />Important: used with a balance sheet or a moment in time, pay attention to Acid Test over time<br />
  8. 8. Acid Test Ratio Example<br />Metal Shop Balance Sheet<br />1997: <br />$(5,310,900-379,506)/ $640,647= 7.7<br />1998:<br />$(19,681,770-1,022,833)/<br />$817,692= 22.82<br />1999:<br />$(58,654,548-2,684,167)/<br />$817,692 = 43.54<br />Options:<br /><ul><li>Invest cash in less liquid assets (inventory, business expansion, stocks)</li></li></ul><li>Uses of Both<br />Used to assess health of company<br />Determine risk of loans<br />Determine if further investments are needed<br />Determine where money should be <br />

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