1.2 Liquidity Flashcards
Liquidity
Ability of a firm to pay its current obligations
Current assets list
Cash and equivalence, marketable securities, receivables net of allowance, inventories and prepaid items
Current liabilities list
Accounts payable, notes payable, current maturity of long-term debt, unearned revenues, taxes payable, wages Payable and other accruals
Net Working capital
Current assets minus current liabilities
Liquidity of current liabilities
Ease with which a firm can issue New Debt OR raise new structured funds-convertible, puttable, callable
A firms ability to borrow is generally a function of its Size, Reputation, Credit Worthiness, and Capital levels
Raising liquidity during adverse situation requires a combination of both asset liquidity and liability Liquidity
Solvency
Ability to pay noncurrent obligations
As they come due
Key ingredients are the firms Capital Structure and Degree of Operating Leverage
Capital structure decisions affect risk profile.For example company was higher percent of Debt capital will be riskier than a firm with a high percentage of equity capital
Why is that Debt financing advantageous
As long as the RETURN on Debt exceeds the amount of interest paid, it is Advantageous because the payments of interest are tax deductible
Capital adequacy
Used in connection with financial institutions. A bank must be able to pay those depositors that demand their money on a given day and still be able to make new loans
Capital structure ratios-Definition
The ratios that report the relative proportions of debt and equity at a given reporting date
Current ratio
Current Assets/
Current Liabilities
Cash ratio
Cash and marketable securities/
Current liabilities
Net working capital ratio
Current assets minus current liabilities/
Total Assets
Net working capital/
Total assets
The most conservative of working capital ratios
Quick ratio or acid test
Cash, accounts receivable, marketable securities/
Current liabilities
Eliminates Uncertainty of inventories
Cash flow ratio
Operating cash flows/
Current liabilities
What are the 6 Liquidity ratios
One. Net working capital Two. Net working capital ratio Three. Current ratio Four. Quick ratio Five. Cash flow ratio Six. Cash ratio
