Liquidity ratios

Liquidity ratios are used to analyze and determine a company’s financial ability to meet short-term liabilities.

Current ratio = Current assets / Current liabilities.
(If <1,> liquidity crisis. If higher-> better the ability to pay ST liability.)

Quick ratio = (Cash + Marketable securities + Receivables) / Current liabilities.
(more stringent measure of liquidity- not incl inventories & other not very liquid asset)

Cash ratio = (Cash + Marketable securities) / Current liabilities.
(most conservative measures)

Receivables turnover = Sales / Average receivables. {ave = (beg + End)/2}
(desirable to have figures close to the industry norm)

Inventory turnover = COGS / Average inventories.
(desirable to have figures close to the industry norm. If the stock level is too low, it is probably to lose sales, if too high, too much cash is tied up.

Payables turnover = COGS / Average payables.

Receivables period = 365 / Receivables turnover.
(no of days receivables ,desirable to have figures close to the industry norm; If too high-> too much capital tied up in assets; If too low-> too rigorous credit policy)

Inventory processing period = 365 / Inventory turnover
(no. of days inventory ,desirable to have figures close to the industry norm, If too high->capital tied up & obsolete inventory; If too low->inadequate stock->adversely impact sales)

Payables period = 365 / Payables turnover.
(no. of days of payables, paying too early is costly unless the firm can take advantage of discounts; Postponing the payment is costly due to the discount foregone, late payment penalties/interest, deterioration of credit rating and business relationship)

Operating Cycle = days of inventory + days of receivable

Cash conversion cycle = days of inventory + days of receivable – days of payable
(if too high-> not desirable, excessive amt of capital investment in the sales process)