# Liquidity Ratios - BC Bookkeeping Tutorials|dwmbeancounter.com Title
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## Liquidity Ratios

Ratios Liquidity Ratios
Liquidity ratios measure a company's ability to pay short term debt obligations (debts due less than a year). In general, a higher liquidity ratio shows a company is more liquid and has a better ability to pay it's outstanding debts. These ratios are normally calculated when financial statements are prepared - monthly, quarterly, and annually.
Cash Ratio
• What It Tells Us: Cash Rato measures a company’s ability to pay off short-term liabilities with cash. It's the most stringent of the liquidity ratios.
• Calculation: Cash divided by Current Liabilities
• Formula: Cash Ratio = Cash / Current Liabilities
• How Normally Expressed: Ratio
• Bad or Good: As a rule of thumb, a cash ratio equal to or greater than 1:1 (1.0) is considered good. A ratio of less than .5:1 (.5) could indicate potential cash flow problems. The greater the ratio, the smaller the risk to creditors. You should use your financial information to spot trends and compare to industry averages if available.
• Additional Clarification: A ratio of 1:1 (1.0 ) means that you have \$1.00 of cash for every \$1.00 of current liabilities. A ratio of .5:1 (.5 ) means that you have \$.50 of cash for every \$1.00 of current liabilities.
Example:
 Cash Ratio Information: Dollars in thousands Month Quarter Year Cash For Period 21 29 34 Current Liabilities For Period 32 33 36 Cash Ratio .66:1 .88:1 .94:1 Cash / Current Liabilities
Our example ratios mean that for the month we had 66 cents, for the quarter we had 88 cents, and for the year we had 94 cents of cash for every \$1.00 of current liabilities.
Quick Ratio (Acid Test)
• What It Tells Us: Quick Ratio measures a company's ability to pay off short-tem liabilities using liquid assets. The acid-test ratio disregards current assets that are difficult to liquidate quickly such as inventory.
• Calculation: (Cash plus Short Term Investments plus Accounts Receivable) divided by Current Liabilities
• Formula: Quick Ratio =  (Cash + Short Term Investments + Accounts Receivable) / Current Liabilities
• How Normally Expressed: Ratio
• Bad or Good: As a rule of thumb, a quick ratio equal to or greater than 1.5:1 (1.5) is considered good; less could indicate potential problems in paying creditors. The greater the ratio, the smaller the risk to creditors. You should use your financial information to spot trends and compare to industry averages if available.
• Additional Clarification: A ratio of 1.5:1 (1.0)  means that you have \$1.50 of liquid assets for every \$1.00 of current liabilities. The greater the ratio, the smaller the risk to creditors.
Example:
 Quick Ratio Information: Dollars in thousands Month Quarter Year Cash For Period 21 29 34 Marketable Securities For Period 2 3 4 Accounts Receivable For Period 22 23 25 Total Quick Assets 45 55 73 Current Liabilities 32 33 36 Quick Ratio 1.4:1 1.7:1 2.0:1 Quick Assets / Current Liabilities
Our example ratios mean that for the month we had \$1.40, for the quarter we had \$1.70, and for the year we had \$2.00 of liquid assets for every \$1.00 of current liabilities.
Current Ratio
• What It Tells Us: Current Ratio measures a business' ability to pay its short-term liabilities with its total current assets such as cash, investments, accounts receivable, prepaid expenses, and inventories.
• Calculation: Current Assets (cash, accounts receivables, investments, prepaid expenses, inventories) divided by Current Liabilities
• Formula: Current Ratio =  Current Assets / Current Liabilities
• How Normally Expressed: Ratio
• Bad or Good: As a rule of thumb,  a current ratio below 1:1 (1.0) could indicate that a company might struggle to pay its short-term obligations; whereas ratios of 2:1 (2.0) or greater would generally indicate ample liquidity. The greater the ratio, the smaller the risk to creditors. You should use your financial information to spot trends and compare to industry averages if available.
• Additional Clarification: A ratio of 2:1 (2.0) means that you have \$2.00 of current assets for every \$1.00 of current liabilities.
Example:
 Current Ratio Information: Dollars in thousands Month Quarter Year Current Assets For Period Cash 21 29 34 Marketable Securities 2 3 4 Accounts Receivable 22 23 25 Prepaid Expenses 4 3 1 Inventory 14 16 21 Current Assets For Period 63 74 85 Current Liabilities For Period 32 33 36 Current Ratio 2.0:1 2.2:1 2.4:1 Current Assets / Current Liabilities
Our example ratios mean that for the month we had \$2.00, for the quarter we had \$2.20, and for the year we had \$2.40 of current assets for every \$1.00 of current liabilities.
Working Capital
Note: While technicaly not a ratio (subtracting instead of dividing), it is a good indicator of liquidity.
• What It Tells Us: Working Capital assesses a business's ability to pay it current liabilities using its current assets.
• Calculation: Current Assets (cash, accounts receivables, investments, prepaid expenses, inventories) minus Current Liabilities
• Formula: Working Capital = Currents Assets - Current Liabilities
• How Normally Expressed: Dollars
• Bad or Good: Within reason, the larger the dollar amount the better. You should use your financial information to spot trends and compare to industry averages if available.
• Additional Clarification: The ratio tells us how much cash we would have if we liquidated our current assets and paid our current liabilities.
Example:
 Working Capital Information: Dollars in thousands Month Quarter Year Current Assets For Period 63 74 85 Current Liabilities For Period 32 33 36 Working Capital 31 41 49 Current Assets - Current Liabilities
Our example ratios mean that for the month we had \$31,000, for the quarter we had \$41,000, and for the year we had \$49,000 more of current assets than current liabilities.
Bad or Good ? In general, a higher liquidity ratio shows a company is more liquid and has a better ability to pay it's outstanding debts.

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