Financial Ratio to Assess Liquidity

What is the financial ratio used to assess a company's liquidity? Liquidity is a measure of the firm's ability to meet its current obligations. Following are the main financial ratios to assess liquidity:

1) Current ratio = Current Assets / Current Liabilities
2) Quick ratio = (Current Assets - Stock) / Current Liabilities
3) Average credit given = (Average Debtors / Net Credit Sales) * 365 Days
4) Average credit taken = (Average Creditors / Net Credit Purchases) * 365 Days
5) Borrowing Ratio = Total borrowings / Net worth

Example:
Calculate the relevant liquidity ratios with the following information:
Debtors: $30,000
Creditors: $37,000
Proposed dividends: $5,000
Bank: $8,000
Cash: $2,000
Stock: $10,000
Capital at end: $350,000
Mortgage loan: $300,000

Solution:
(1) Current ratio = 50,000 / 42,000 = 1.19
This means that current assets are 1.19 times current liabilities.
(2) Quick ratio = (50,000 - 10,000) / 42,000 = 0.95
This means that liquid assets are 0.95 times current liabilities.
(3) Borrowing Ratio = Total borrowings / Net worth = 300,000 / 350,000 = 0.86 (i.e., 86% geared)
Workings:
Current assets = stock + debtors + bank + cash = 10,000 + 30,000 + 8,000 + 2,000 = $50,000
Current liabilities = creditors + proposed dividends = 37,000 + 5,000 = $42,000

* Next: Ratio Analysis Questions and Answers

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