Financial Ratios

4404 Words Feb 21st, 2011 18 Pages
FINANCIAL RATIOS

LIQUIDITY RATIOS

Current Ratio: = current assets / current liabilities

▪ The higher the ratio, the greater the "cushion" between current obligations and a firm 's ability to meet them. ▪ Use: An indication of a company 's ability to meet short-term debt obligations; the higher the ratio, the more liquid the company is. Current ratio is equal to current assets divided by current liabilities. If the current assets of a company are more than twice the current liabilities, then that company is generally considered to have good short-term financial strength. If current liabilities exceed current assets, then the company may have problems meeting its short-term obligations. For example,
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Inventory to Net Working Capital:

(Current assets – current liabilities) Net Working Capital

▪ Its use and what constitutes a “good” or “bad” indication/comparison:

▪ Use: indicates I too high of a proportion of current working capital is in inventory. Inventory is a less liquid resource than cash too high a level of inventory can indicate the inability to turn working capital into cash to meet short- term obligations.

▪ Good:

▪ Bad: If the number is high compared to the average in the industry it could mean that the business is carrying too much inventory.

▪ Who uses it and for what purpose? This ratio tells how much of a company 's funds are tied up in inventory. It is preferable to run your business with as little inventory as possible on hand, while not affecting potential sales opportunities

▪ How it can be manipulated or what causes it to vary?

▪ How can Management Leverage this knowledge?

Cash Ratio: = Cash Equivalents + Cash / Current Liabilities (Accruals + Accounts Payable + Notes Payable)

▪ Known also as the Cash Asset Ratio and Liquidity Ratio ▪ Seen as the most conservative of the three liquidity ratios. ▪ Its use and what constitutes a “good” or “bad” indication/comparison: ▪ Use: measures the most liquid of all assets against current liabilities. Measures the extent to which a corporation or other entity can quickly liquidate assets and cover short-term liabilities,

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