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Liquidity Ratios Essay

Company’s ability to pay off its debt due in a year is assessed by its liquidity, which is the readiness of the assets to turn into cash. Liquidity of a company is measured by its current assets. There are two major ratios largely used to determine the company’s liquidity and they are; 1. Current Ratio 2. Acid Test/ Quick Ratio Current Ratio – In this ratio all the current assets are taken into account while measuring the liquidity. Current Ratio = Current Assets/ Current Liabilities From the above figures we can say that current ratio has gone down to 1.

31 from 2. 16. It shows that in the year in 2007 company was liquid enough to pay twice of its debt but in year 2008 it is able to pay 1. 31 times of its current liabilities. Ideal ratio is 1 and in both the years company is maintaining good liquidity and is showing string signs of meeting its working capital requirement. Acid test Ratio – In current asset most liquid assets are used and balance sheet items like inventory are not taken into account as a certain time period is required to convert the inventory in to cash.

(Brigaham &

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Ehrhardt, 2002) This ratio explains the immediate liquidity of company, and higher this ratio that better is the company’s cash management cycle. Acid Test Ratio = (Current Assets- Inventory)/ Current Liabilities In this company current assets only include cash &

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stocks hence the asset test ratio would be same as current ratio. 4. 2 Asset Management Ratio – these ratios explains company’s efficiency in terms of managing its asset, from the given items in the balance sheet only two ratios pertain in the analysis.

Fixed Assets Turnover – Fixed Assets Turnover projects company’s effectiveness in using its fixed assets to increase the over all revenue of the company, to be precise we can say that how much utilization of assets is taking place. Fixed Assets Turnover = Sales/ Net Fixed Assets Ratio above is showing that in the year 2007 ratio was 7. 4 times and it reduced to 5. 3 times in year 2008. It shows that company’s effectiveness in using its asset to create revenue has gone down.

This shows that company has kept ideal assets which its not utilizing in manufacturing products and these unused assets should be laid off in order t avoid unnecessary maintenances cost. (Brigaham &

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Ehrhardt, 2002) Total Assets Turnover Ratio – this ratio take into account total assets effectiviness and utilization in creating sales of the compnay. Total Assets Turnover = Sales/ Total Assets Above figures showing that total asset turnover figure went down in year 2008.

It shows the company has lost its efficiency in using its assets properly over a year and the higher figure in 2007 shows that company has the capacity to put its assets to full use, hence we can say that resources required in production may not be available which is the reason why the total asset turn over is low in year 2008. 4. 3 Profitability Ratios Profitability explain the impact of three ratios; debt, liquidity and asset management of the company.

We will look into the relevant ratios of profitability in this section; Profit Margin on Sales Profit margin on sales gives the profit earned on every 1?. It is calculated by employing following formula Bibliography Brigham, E. F. , &

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Ehrhardt, M. C. (2006). Financial Management; Theory &

Need essay sample on "Liquidity Ratios"? We will write a custom essay sample specifically for you for only $ 13.90/page

Practice. Bangalore, India: Eastern Press Wild, J. J. , Subramanyum. K. R. &

Need essay sample on "Liquidity Ratios"? We will write a custom essay sample specifically for you for only $ 13.90/page

Halsey, R. F. (2003). Financial Statement Analysis Wood, F. , &

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Sangster, A. (2004). Business Accounting, Delhi, India; Pearson Education

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