Liquidity Ratios Flashcards
(18 cards)
Liquidity
is the firm ability to pay its current obligations as they come due and thus remain in business in the short run .
-liquidity reflects the ease with which assets can converted into cash.
liquidity measure this ability by relating firm’s …..[continue]
firm’s liquid assets to its current liabilities
Current assets
are the most liquid and expected to be converted into cash, sold or consumed within 1 year or operating cycle whichever is longer
Current assets Include in descending order of liquidity
Cash and cash equivalents Marketable securities Receivable Inventories and prepaid items
Current liabilities
are ones that must be settled the soonest. Specifically they are expected to be settled or converted to other liabilities with in one year or operating cycle whichever is longer.
Current liabilities include :
- accounts payable
- notes payable
- current maturities of long term debt
- unearned revenue
- taxes payable
- wages payable
- and other accruals.
Net Working Capital
reports the resources the company would have to continue operating in the short run if it had to liquidate all of its current liabilities at once
=current assets - current liabilities
current ratio
the most common ratio of liquidity
=current assets / current liabilities
a low current ratio indicates what?
a possible solvency problem, a firm with a low current ratio firm become insolvent. therefore care should be taken when determining whatever to extend credit to a firm with low ratio.
A overly high current ratio indicates what ?
that management may not be investing idle assets productively
Obsolete or overvalued inventory or receivable can cause what ?
can cause artificially inflate the current ratio. so the qualities of accounts receivable and merchandise inventory should be considered before evaluating current ratio
current ratio should be proportional to the operating cycle [explain]
a shorter cycle may justify a lower ratio , for example a grocery store has a short operating cycle and survive with a lower current ratio than a gold mining company, which has a much longer operating cycle.
Quick (acid test) ratio
excludes inventory and prepaids from numerator
Cash Ratio
[ Cash + marketable securities ] / Current Liabilities
Cash Flow Ratio
Cash Flow From Operation / current liabilities
- Reflects the significance of cash flow for settling obligations as they become due
Net Working Capital Ratio
is the most conservative of the working capital ratio
net working capital/current liabilities
Name of all liquidity ratios
Current ratio quick ratio - acid test cash ratio cash flow ratio net working capital ratio in addition to net working capital formula
when the ratio is more than 1 - and increase the numerator and dominator by the same value the results will be ?
…….
