## 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 |

**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 |

**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 |

**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 |

**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.

Now, let's check out

**Solvency Ratios**