Finance: Liquidity Ratios

Question 1

What are Liquidity Ratios?

Answer 1

Assess whether business has sufficient cash or equivalent current assets to be able to pay its debts as they fall due

Question 2

What does an income statement do?

Answer 2

Measures business performance over given period of time, usually 1 year. Compares income of business against cost of goods/services and expenses incurred in earning that revenue

Question 3

What is a balance sheet?

Answer 3

Snapshot of business’ assets (what owns or is owed) and its liabilities (what it owes) on particular day

Question 4

What is a cash flow statement?

Answer 4

Shows how business has generated and disposed of cash and liquid funds during period under review

Question 5

What is liquidity determined by?

Answer 5

Relationship between current assets & current liabilities

Question 6

What type of current assets are there?

Answer 6

• Cash
• Inventory
• Debtors

Question 7

What types of current liabilities are there?

Answer 7

• Creditors

- Overdraft

Question 8

What would a ratio of 1.5 - 2.5 suggest?

Answer 8

Acceptable liquidity & efficient management of working capital.

Question 9

What would a ratio below 1 suggest?

Answer 9

Possible liquidity problems.

Question 10

What would a high ratio suggest?

Answer 10

Too much working capital tied up in inventories or debtors?

Question 11

Top grade evaluation of current ratios:

Answer 11

The industry or market matters

• Firms have different requirements for holding inventories, or approaches to trade debt and credit
• How does current ratio compare with competitors?

The trend is more important
- Sudden deterioration in current ratio is good indicator of liquidity problems.