Liquidity Ratios

Question 1

Major Liquidity Measures

Answer 1

1 Working Capital - Measures extent to which current assets exceed current liabilities and are uncommitted in short term

Current Assets - Current Liability

2 Working Capital Ratio (Current Ratio) “number of times” current assets can cover current liabilities

Current assets/current liabilities

3 Acid Test - ighly liquid assets and current liabilities in terms of the “number of times”

Cash + Net REC + Marketable Securities / Current Liabilities

4 Defensive interval ratio - highly liquid assets and the average daily use of cash in terms of the number of days that cash and assets that can be quickly converted to cash can support operating costs

(Cash + (Net) Receivable + Marketable Securities) / Average Daily Cash Expenditures

5 Average collection period - Number of days on average it takes an entity to collect AR; AR to Cash days

Days in year x Average AR / Credit Sale for Period

6 Times interest earned ratio - Ability of current earnings to cover interest payments

NI + Interest Expense + Income Tax Expense / Interest Expense

7 Times preferred dividends earned ratio - Measures ability of current earnings to cover preferred dividends for a period

NI / Annual Preferred Dividend Obligation