Which users are interested in liquidity ratios

Key Takeaways Key Points Ratio analysis consists of the calculation of ratios from financial statements and is a foundation of financial analysis. A financial ratio, or accounting ratio, shows the relative magnitude of selected numerical values taken from those financial statements. Ratio analysis is one method an investor can use to gain that understanding. Key Terms liquidity : Availability of cash over short term: ability to service short-term debt.

Licenses and Attributions. CC licensed content, Shared previously. In healthy companies, this ratio result should be in excess of 1. A ratio value of less than 1. For example, it may be possible that receivables or inventory comprise too large of a portion of working capital. In other words, it is important to understand if less liquid components comprise the bulk of liquid assets, particularly when the ratio result is strong.

The quick ratio is a more conservative liquidity indicator because it excludes inventory from the numerator. Inventory is generally less liquid than accounts receivable. A result of 1. The cash ratio measures cash and cash equivalent balances relative to current liabilities. It is an extreme liquidity ratio because other generally liquid assets like accounts receivable and inventory are excluded from the numerator.

It measures the ability of a business to repay its current liabilities by only using its cash and cash equivalents. Cash equivalents are assets which can be converted into cash quickly, whereas current liabilities are liabilities which are to be settled within 12 months or the business cycle.

A cash ratio of 1. The ratio is usually below 1. A result close to 0. This is because while other classes of stakeholders do not have control over the working of the firm i. All the other stakeholders question the management at the annual general meeting. Hence, management tries to get as much insight into the ratios as possible. They create operating performance ratios and compare it to their previous performance and to the performance of others to learn from the past as well as to be able to give satisfactory answers to the investors.

Shareholders, for obvious reasons, are most concerned about profitability. Their investments are at risk and they expect to gain the maximum. Investors scrutinize profitability numbers and pounce upon the slightest signs of mismanagement. For the shareholders, the profitability ratios are the beginning point. They then follow the trail the ratios leave.

However over the past two decades the focus has been steadily shifting towards cash flow ratios.