Liquidity Ratios The financial health of a business greatly depends on its ability to maintain current commitments and obligations. Liquidity or the ability to generate cash from current assets to meet short-term obligations as well as unforeseen responsibility is important for the subsistence of a company. “A reasonable level of liquidity is essential to the survival of a company, as poor cash control is one of the main reasons for business failure. (Pyke, 2007) Through utilization of tools, such as liquidity ratios, or financial metrics, to evaluate the company’s ability to meet current business obligations, should the debt needs to be settled, we are able to assess its immediate financial strength. Liquidity ratios provide creditors as well as businesses a quick analysis tool, using data, which are readily available from annual financial statements, to complete these assessments. These ratios are critical to creditors and are “the most widely used ratios, perhaps next to profitability ratios.” (Joe Lan, 2002) Liquidity ratios include current ratio, quick ratio (also referred to as acid-test ratio), net working capital ratio, and cash ratio. Current ratio is the most basic or fundamental of the four and focuses mainly on current assets, while quick ratio is more stringent, eliminating inventory and prepaid expenses, as both are more difficult to liquidate (Morningstar, 2016). Cash ratio is the most “conservative”, as it mainly focuses on cash and investments
Professor Thomas Piper prepared the original version of this note, “Assessing a Firm’s Future Financial Health,” HBS No. 201-077, which is being
Liquidity ratios measure the capability of a business to cover expenses and meet its current and long-term responsibility. These ratios are imperative in order to keep the business alive. Lending institutions are typically unwilling to loan money to a business that finds itself in a cash flow jam, because that is often a sign of poor management. The liquidity is measured with 3 different ratios; current ratio, turnover – of – cash ratio and debt- to equity ratio.
1. Liquidity ratios are a class of financial metrics that is used to determine a company's ability to pay off its short-terms debts obligations. Generally, the higher the value of the ratio, the larger the margin of safety that the company possesses to cover short-term debts.
The liquidity of firm can be measured by computing certain ratio’s such as current ratio and acid ratio. For measuring Target Corporation’s 2014 liquidity; the firm’s current ratio and the acid ratio is computed. The company’s current ratio is 0.91 times which is computed by comparing current asset ($11, 573,000) with current liabilities ($12,777, 000) of the year 2014 (TGT Company Financial, n.d). The firm’s acid ratio is 0.26 times which is computed by deducting inventory ($8,278,000) from current assets. The inventory is deducted from current assets because the company has not received any money for the unfinished good or from unsold inventory worth ($8,278,000). To analyze the Target Corporation’s liquidity trend in 2014; the current ratio and acid ratio of 2014 is compared with the 2015’s ratios. In 2015, the firm’s current ratio was 1.20 times and the acid ratio was 0.45 times. These liquidity ratios reflect that the firm’s liquidity was better in 2015 than 2014. (See Table 1).
In the case of Assessing a Company’s Future Financial Health, the case concentration is on SciTronics, a medical device company, performance measures based on the organization’s three primary financial data sources in Exhibit 1 & 2. Utilizing the 9 steps of corporate financial system, I will be able to analyze the financial health of the company to assess whether it will remain balance over the ensuing 3-5 years. The measures are grouped by focusing on “Financial Ratios” such as: 1.) profitability measures, 2) activity measures, and 3) leverage and liquidity measures. Using the financial data sources, I would be able to make recommendations regarding SciTronics 126 million loan request.
This ratio is similar to current ratio, except that it excludes inventory from current assets. Inventory is subtracted because it is considered to be less liquid than other current assets, that is, it cannot be easily used to pay for the company’s current liabilities. A company having a quick ratio of at least 1.0, is considered to be financially stable. It has sufficient liquid assets and hence, it will be able to pay back its debts easily (Qasim Saleem et al., 2011).
“The current ratio is a liquidity and efficiency ratio that measures a firm’s ability to pay off its short-term liabilities with its current assets” (Current Ratio 2018). Since current liabilities are often due in less than a year, the current ratio plays a signifcant role in measuring the company’s liquidity. In other words, the company’s window of opportunity to obtain the funds necessary to cover current liabilities is short. Furthermore, the company relies on its ability to secure its most liquidable assets, which include: cash, cash equivalents, and marketable securities, and then being able to convert them into short-term funds. If the company is unable to obtain the necessary funds to cover its short-term obligations, the company may
Overall regards to liquidity ratios, the higher the number the better; however, a too high also indicates that the firms were not using their resources to their full potential. Current ratio of 1.0 or greater shows that a company can pay its current liabilities with its current assets. JWN’s ratio increased from 2.06 in 2007 to 2.57 in 2010, and slightly decreased to 2.16 in 2011. JWN’s cash ratio increased significantly from 22% in 2007 to 80% in 2010. JWN has a cash ratio of 73% in 2011, which is useful to creditors when deciding how much debt they would be willing to extend to JWN. In addition, JWN also has moderate CFO ratio of 46%, indicating the companies’ ability to pay off their short term liabilities with their operating cash
These ratios are computed to judge the short term liquidity of the business. Two most important liquidity ratios are current ratio and quick ratio. These ratios determine the ability of firm to meets its current liabilities out of its current/quick assets.
The Quick Ratio also known as Acid Ratio is used by firms to determine liquidity position. It explains if the firm is able to pay all of their current debt liabilities. (Dyson, 2010) The graph above illustrates that over the period from 2007 to 2011 quick ratio was not more that 1, which means that their debts might not be covered all. The graph also indicates that a peak was in 2011.
Liquidity ratios measure the short term ability of a company to pay its obligations and meet their needs for maintaining cash. According to Cagle, Campbell & Jones (2013), “A good assessment of a company’s liquidity is important because a decline in liquidity leads to a greater risk of bankruptcy” (p. 44). Creditors, investors and analysts alike are all interested in a company’s liquidity. After computing liquidity
Liquidity ratios measure the ability of a firm to meet its short-term obligations. A company that is not able
Current Ratio is the measure of short-term liquidity. It indicates that the ability of an entity to meet its
These ratios help company in determining its capability to pay short-term debts. Liquidity ratios inform about, how quickly a firm can obtain cash by liquidating its current assets in order to pay its liabilities. General liquidity ratios are: current ratio and quick ratio. Current ration can be obtain by dividing company’s current assets by its’ current liabilities. Generally a current ratio of two is considered as good (Cleverley et al., 2011). Quick ratio also known as acid test determines company’s liabilities that need to be fulfilled on urgent basis. Quick ratio can be obtained by dividing quick assets by current liabilities. Quick ratio is considered as stricter because it excludes inventories from current assets. Generally a quick ratio of 1:1 is considered as good for the company. Higher quick
그리고 아직 지불되지 않은 판매 기간(the number of days of sales that are still unpaid)을 결정하기 위해 외상매출금(accounts receivable)을 credit sales per day로 나누어라.