liquidity ratio
Ability to satisfy its short-term obligations as they come due This is called a liquidity ratio.
The two basic measures of liquidity are:
the current ratio
the quick ratio
current ratio:
current ratio one of the most commonly cited financial ratios - the forms ability to meet
short-term publications it is expressed as
Formula:
current ratio = current asset / current abilities
Higher current ratio indicates a greater degree of liquidity
Quick (acid test ratio) or liquid ratio:
liquidity calculated by dividing the firm is current assets minus inventory by its current liabilities
The quick ratio is calculated as:
quick ratio = current asset - inventory / current liabilities
The generally low liquidity of inventory results from two primary factors
1: many types of inventory cannot be easily sold because they are partially completed items,
special purpose items, and the like and 2: inventory is typically sold on credit which mea that
it becomes an account receivable before being converted into cash.
Activity ratios or efficiency or turnover ratio:
activity ratios Measures the speed with which various accounts are converted into sales or
cash or inflows or outflows.
The four basic measures of activity ratios are:
inventory turnover
average collection period
the average payment period
the total asset turnover
Inventory turnover:
inventory turnover measures the activity on liquidity of firms inventory
it is calculated as:
inventory turnover = cost of goods sold / inventory
The resulting turnover is meaningful only when it is compared with that of other firms in
the same industry or to the firm's past inventory turnover.
Average collection period:
the average amount of time needed to collect accounts receivable.
it is calculated as:
average collection period = account receivable / average sales per day
OR
Average collection period = account receivable / annual sales
Average payment period:
the average amount of time needed to pay accounts payable.
it is calculated as:
average payment period = accounts payable / average purchase per day
OR
Average payment period = accounts payable / annual purchases
Total asset turnover:
The total asset turnover indicates the efficiency with which the firm uses its assets to generate
sales.
it is calculated as:
total asset turnover = sales / total assets
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