Using Accounting Ratios to Measure Your Company's Financial Health
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Make Business Metrics More Meaningful
(1) Liquidity Ratios
In examining financial statements, determining a business entity’s liquidity can be first priority. The ability of a company to meet its current and immediate financial demands, is an indication of a smooth and profitable operation. The company may have a substantial amount of cash on hand and in banks, but this is not the only indication of liquidity. Unless the relevance of the cash balance to all other accounts had been evaluated. A brief glance at financial data will not suffice, to ascertain the liquidity of a company or entity. Knowing the company’s sources of funds, is vital before making any investment decisions. Hence, the following financial accounting ratios may be used as tests of a company’s liquidity:
Quick Asset Ratio Formula
(Cash+ Accounts Receivable+ Short-term Investments) ⁄ Current Liabilities
Unlike in current ratio, the current assets to be considered here are those that can be readily converted into cash with a considerable amount of certainty. Merchandise inventory and prepaid expenses are not included since there is greater uncertainty as to when it can be converted into actual funds. The objective is to determine the ability of the company to settle short–term obligations at any time that its settlement is demanded. Again, a ratio of more than 1:1 would be favorable.
The objective of this ratio is to determine how fast the quick assets can be converted into cash, since the shortness of time is essential to its conversion. The answer to this formula is expressed in terms of days.
Please proceed to the next page for a continuation of the common formulas for accounting ratios.