Liquidity Ratio

LIQUIDITY ANALYSIS Liquidity ratios are the ratios that measure the ability of a company to meet its short term debt obligations. These ratios measure the ability of a company to pay off its short-term liabilities when they fall due.

The liquidity ratios are a result of dividing cash and other liquid assets by the short term borrowings and current liabilities. They show the number of times the short term debt obligations are covered by the cash and liquid assets. If the value is greater than I, it means the short term obligations are fully covered. Generally, the higher the liquidity ratios are the higher the margin of safety that company posses to meet its current liabilities. Liquidity ratios greater than I indicate that the company is

Quick assets include those current assets that presumably can be quickly converted to cash at close to their books values. A company with a quick ratio of less than 1 cannot currently fully pay back its current liabilities. Note that inventory is excluded from the sum of assets in the quick ratio, but included in the current ratio. Ratios are tests of viability for business entities but do not give a complete picture of the business health. If a business has large amounts in Accounts Receivable which are due for payment after a long period (say 120 days), and essential business expenses and accounts payable due for immediate payment, the quick ratio may look healthy when the business is actually about to run out of cash. In contrast, if the business has negotiated fast payment or cash from customers, and long term from suppliers, it may have a very low quick ratio and yet be very healthy. Generally, the acid test ratio should be 1:1 or higher; however this varies widely by industry. In general, the higher the ratio, the greater the company 's liquidity (ie, the better able to meet current obligations using liquid

Helpful in Decision Making

All our financial statements are made for providing information. But this information is not helpful for decision making because financial statements provide only raw information. When we calculate different ratios in ratio analysis, at that time, we get useful information. I can explain it with simple example. Suppose, we calculate our interest coverage ratio which is 10times but our competitor company 's interest coverage ratio is 15 times. It means capacity of the profit of our competitor company is more than us. By seeing this we can take decisions for increasing our profitability.

2. Helpful in Financial Forecasting And Planning

Every year we calculate lots of accounting ratios. When we make trend of all these ratios, we can get useful information for our future forecasting and planning. For example, we can tell five year collection period with following way from this trend, we know that we are decreasing the days for collection money from our debtors. With this information, we can make two plans. One is effective use of money which we are getting from our debtors more fastly and second we can also check the behavior of our debtors by comparing this with sales trend. Like this, there are lots of ratios which are also useful for better