This document discusses liquidity ratios and ratio analysis. It defines liquidity ratios as ratios used to test a company's short-term solvency and ability to pay off current liabilities with current assets. The two main liquidity ratios discussed are the current ratio, which compares current assets to current liabilities, and the quick ratio, which compares quick current assets to current liabilities. The document provides examples of how to calculate these ratios using sample company financial data and interprets the results. It concludes by noting some limitations to ratio analysis for financial evaluation and comparison purposes.

1. LIQUIDITY RATIOS

2. SYNOPSIS
• Ratio analysis
• Liquidity ratios
• Current ratio
• Quick ratio
• Limitations of Ratio analysis
• conclusion

3. RATIO ANALYSIS
 It is a method or process by which the relationship of items or groups
of items in the financial statements are computed, and presented.
 In other words Ratio analysis is the process of determining and
interpreting numerical relationship based on financial statements.
 Important tool of financial analysis.
 Ratio can be expressed as
I. Percentage(ex: 10% of sales ,20% of revenues)
II. proportion(ex: 1:4,2:3)
III. pure number /times(ex: sale is 4 times of profit)

4. LIQUIDITY RATIOS
 The liquidity ratios are used to test the short term solvency or liquidity
position of the business.
 It enables to know whether short term liabilities can be paid out of
short term assets.
 It indicates whether a firm has adequate working capital to carry out
routine business activity.
 Important ratios in liquidity
I. current ratio
II. quick ratio/acid test

5. CURRENT RATIO
 It is the relationship between the current assets and current liabilities of
a concern.
Current Ratio = Current Assets/Current Liabilities
 Current Assets : Raw Material, Stores, Spares, Work-in Progress.
Finished Goods, Debtors, Bills Receivables, Cash.
 Current Liabilities : Sundry Creditors, Installments of Term Loan,
DPG etc. payable within one year and other liabilities payable within
one year.
 Ideal ratio is 2:1
 High ratio indicates under trading and over capitalization.
 Low ratio indicates over trading and under capitalization.
 The ideal Current Ratio preferred by Banks is 1.33 : 1.

6. Contd..
 Example: If the Current Assets and Current Liabilities of a concern are
Rs.4,00,000 and Rs.2,00,000 respectively, then
Current Ratio will be : Rs.4,00,000/Rs.2,00,000 = 2 : 1.
Company A
Current Assets: 500,000Rs
Stock: 200,000Rs Cash: 100,000Rs Debtors: 200,000Rs
Current Liabilities: 350,000Rs
Current ratio = 500,000/350,000
Current Ratio- 1.43:1
Meaning: For every 1 rupee of current liabilities, the firm has 1.43 of
current assets.

7. ACID TEST/QUICK RATIO
 It is the ratio between Quick Current Assets and Current Liabilities.
The should be at least equal to 1.
Acid Test or Quick Ratio = Quick Current Assets/Current Liabilities.
 Quick Current Assets : Cash/Bank Balances ,Receivables up to 6
months ,Quickly realizable securities such as Govt, Securities or
quickly marketable/quoted shares and Bank Fixed Deposits.
 Conventionally a quick ratio of 1:1 is considered satisfactory.
 If the ratio is too high, the company may be holding excessive liquid
assets.
 If the ratio is too low, the company may have a liquidity problem / cash
flow problem.

8. Contd..
Company A
Current Assets: 500,000
Stock: 200,000 Cash: 100,000 Debtors: 200,000
Current Liabilities: 350,000
(500,000- 200,000)= 300,000
_______________
350,000
Acid Test Ratio- 1:1.12
Meaning: For every Rs.1.12 of current liabilities, the firm has Rs.1 of
(current assets- stocks) = Possible that the firm is experiencing a
LIQUIDITY CRISIS!!

9. LIMITATIONS OF RATIO ANALYSIS
 Changes in price level will affect the comparability of the ratios
between two financial periods.
 Changes in external environment will affect the comparison.
 Different accounting definitions, methods, techniques and policies
used by various businesses may affect the comparability.
 Qualitative factors are not considered.
 Organizational objectives differ between businesses (misleading) Ex.
Supermarkets and Jewelry shops.
 It is difficult to set up a proper standard for good performance.
 Short term fluctuations may not be reflected.

10. CONCLUSION

11. THANK YOU!!!