Liquidity ratios Flashcards
Liquidity is the ability of an enterprise to be able to pay its short-term debts (current liabilities).
What measure the liquidity of an enterprise?
1) The current ratio
2) The liquid capital ratio
measure the liquidity of an enterprise
An enterprise’s current assets must be …?
An enterprise’s current assets must be greater than its current liabilities
An enterprise’s current assets must be greater than its current liabilities, so that it …?
An enterprise’s current assets must be greater than its current liabilities, so that it is able to pay its bills
Current assets are made up of both what?
Current assets are made up of both:
1) Cash
2) Inventory (stock)
Current assets are made up of both cash and inventory (stock).
If an enterprise’s current assets are mainly in the form of inventory, what?
If an enterprise’s current assets are mainly in the form of inventory, it may have difficulty paying its liabilities
To understand the liquidity of an enterprise, two ratios are calculated: one which … and another which …?
To understand the liquidity of an enterprise, two ratios are calculated:
1) One which includes the inventory (stock)
2) Another which excludes it
To understand the liquidity of an enterprise, two ratios are calculated: one which includes the inventory (stock) and another which excludes it.
The information for these ratios is extracted from where?
The information for these ratios is extracted from the statement of financial position
To understand the liquidity of an enterprise, two ratios are calculated: one which includes the inventory (stock) and another which excludes it.
The information for these ratios is extracted from the statement of financial position.
Current ratio:
What is current ratio?
Current ratio is the ratio of total current assets and liabilities
To understand the liquidity of an enterprise, two ratios are calculated: one which includes the inventory (stock) and another which excludes it.
The information for these ratios is extracted from the statement of financial position.
Current ratio:
Current ratio is the ratio of total current assets and liabilities.
What does it include?
It includes both:
1) Cash
2) Inventory (stock)
To understand the liquidity of an enterprise, two ratios are calculated: one which includes the inventory (stock) and another which excludes it.
The information for these ratios is extracted from the statement of financial position.
Current ratio:
Current ratio is the ratio of total current assets and liabilities. It includes both cash and inventory (stock).
It is a useful measure of the enterprise’s ability to do what?
It is a useful measure of the enterprise’s ability to pay its debts
To understand the liquidity of an enterprise, two ratios are calculated: one which includes the inventory (stock) and another which excludes it.
The information for these ratios is extracted from the statement of financial position.
Current ratio:
Current ratio is the ratio of total current assets and liabilities. It includes both cash and inventory (stock).
It is a useful measure of the enterprise’s ability to pay its debts, but may be misleading if what?
It is a useful measure of the enterprise’s ability to pay its debts, but may be misleading if current assets largely consist of inventory
To understand the liquidity of an enterprise, two ratios are calculated: one which includes the inventory (stock) and another which excludes it.
The information for these ratios is extracted from the statement of financial position.
Liquid capital ratio:
If an enterprise needs to pay debts in the near future, such as wages, it will need to have what?
If an enterprise needs to pay debts in the near future, such as wages, it will need to have cash
To understand the liquidity of an enterprise, two ratios are calculated: one which includes the inventory (stock) and another which excludes it.
The information for these ratios is extracted from the statement of financial position.
Liquid capital ratio:
If an enterprise needs to pay debts in the near future, such as wages, it will need to have cash.
The liquid capital ratio is a more … measure of the enterprise’s liquidity?
The liquid capital ratio is a more accurate measure of the enterprise’s liquidity
To understand the liquidity of an enterprise, two ratios are calculated: one which includes the inventory (stock) and another which excludes it.
The information for these ratios is extracted from the statement of financial position.
Liquid capital ratio:
If an enterprise needs to pay debts in the near future, such as wages, it will need to have cash.
The liquid capital ratio is a more accurate measure of the enterprise’s liquidity, as it does what?
The liquid capital ratio is a more accurate measure of the enterprise’s liquidity, as it removes inventory (stock) from the calculation
To understand the liquidity of an enterprise, two ratios are calculated: one which includes the inventory (stock) and another which excludes it.
The information for these ratios is extracted from the statement of financial position.
Liquid capital ratio:
If an enterprise needs to pay debts in the near future, such as wages, it will need to have cash.
The liquid capital ratio is a more accurate measure of the enterprise’s liquidity, as it removes inventory (stock) from the calculation, since what?
The liquid capital ratio is a more accurate measure of the enterprise’s liquidity, as it removes inventory (stock) from the calculation, since stock may be difficult to turn into cash quickly
To understand the liquidity of an enterprise, two ratios are calculated: one which includes the inventory (stock) and another which excludes it.
The information for these ratios is extracted from the statement of financial position.
What is the formula for current ratio?
The formula for current ratio is:
Current ratio = Current assets ÷ Current liabilities
To understand the liquidity of an enterprise, two ratios are calculated: one which includes the inventory (stock) and another which excludes it.
The information for these ratios is extracted from the statement of financial position.
What is the formula for liquid capital ratio?
The formula for liquid capital ratio is:
Liquid capital ratio = (Current assets - Inventory) ÷ Current liabilities
To understand the liquidity of an enterprise, two ratios are calculated: one which includes the inventory (stock) and another which excludes it.
The information for these ratios is extracted from the statement of financial position.
Interpreting current and liquid capital ratios:
Current assets must be … than current liabilities?
Current assets must be higher than current liabilities
To understand the liquidity of an enterprise, two ratios are calculated: one which includes the inventory (stock) and another which excludes it.
The information for these ratios is extracted from the statement of financial position.
Interpreting current and liquid capital ratios:
Current assets must be higher than current liabilities.
What will most enterprises accept for the current ratio, as it includes inventory?
Most enterprises will accept 2.1 for the current ratio, as it includes inventory
To understand the liquidity of an enterprise, two ratios are calculated: one which includes the inventory (stock) and another which excludes it.
The information for these ratios is extracted from the statement of financial position.
Interpreting current and liquid capital ratios:
Current assets must be higher than current liabilities.
Most enterprises will accept 2.1 for the current ratio, as it includes inventory.
If either ratio falls below 1:1, what?
If either ratio falls below 1:1, the enterprise will struggle to pay its debts
To understand the liquidity of an enterprise, two ratios are calculated: one which includes the inventory (stock) and another which excludes it.
The information for these ratios is extracted from the statement of financial position.
Interpreting current and liquid capital ratios:
Current assets must be higher than current liabilities.
Most enterprises will accept 2.1 for the current ratio, as it includes inventory.
If either ratio falls below 1:1, the enterprise will struggle to pay its debts, why?
If either ratio falls below 1:1, the enterprise will struggle to pay its debts, because it has insufficient cash
To understand the liquidity of an enterprise, two ratios are calculated: one which includes the inventory (stock) and another which excludes it.
The information for these ratios is extracted from the statement of financial position.
Interpreting current and liquid capital ratios:
Current assets must be higher than current liabilities.
Most enterprises will accept 2.1 for the current ratio, as it includes inventory.
If either ratio falls below 1:1, the enterprise will struggle to pay its debts, because it has insufficient cash.
What would it be advised to do?
It would be advised to:
1) Reduce the quantity of its inventory
2) Increase its cash levels
