Ratio analysis - Liquidity Ratios

Liquidity Ratios

This type of ratio helps in measuring the ability of a company to take care of its short-term debt obligations. A higher liquidity ratio represents that the company is highly rich in cash.

The types of liquidity ratios are: –
Current Ratio or Working Capital Ratio
Quick Ratio or Liquidity Ratio or Acid Test Ratio
Absolute Liquid Ratio or Cash Ratio
Stock to Working Capital Ratio
Current Ratio: The current ratio is the ratio between the current assets and current liabilities of a company. The current ratio is used to indicate the liquidity of an organization in being able to meet its debt obligations in the upcoming twelve months. A higher current ratio will indicate that the organization is highly capable of repaying its short-term debt obligations.




Current Ratio = Current Assets / Current Liabilities

Current Assets:
Current Assets means cash and those assets which can be converted into cash within one year in ordinary course of business.

Current Liabilities:
Current Liabilities are those which are to be paid by the firm in one year.
Quick Ratio or Liquidity Ratio or Acid Test Ratio :
The quick ratio is used to ascertain information pertaining to the capability of a company in paying off its current liabilities on an immediate basis.
The formula used for the calculation of a quick ratio is-
Quick Ratio = (Cash and Cash Equivalents + Marketable Securities + Accounts Receivables) / Current Liabilities
. Absolute Liquid Ratio or Cash Ratio:

The cash ratio measures a company’s ability to pay off short-term liabilities with cash and cash equivalents:

Cash ratio = Cash and Cash equivalents / Current Liabilities

Stock to Working Capital Ratio:

It is calculated by dividing the value of stock (or inventories such as raw materials, work in progress, finished goods, stores and packing materials) by the Working capital.

1. MANAGEMENT ACCOUNTING Ratio Analysis By: Smt.UMA MINAJIGI REUR HEAD, DEPT. OF COMMERCE & Management Smt. V G Degree College for Women, Kalaburagi

2. MANAGEMENT ACCOUNTING Ratio Analysis Liquidity ratios - 2

3. An analysis of financial statements with the help of ratio is called Ratio Analysis. Ratio refers to Numerical or Quantitative relationship between two items. What are Financial Ratios? Financial ratios are created with the use of numerical values taken from  financial statements  to gain meaningful information about a company. The numbers found on a company’s financial statements –  balance sheet ,  income statement , and  cash flow statement  – are used to perform  quantitative analysis  and assess a company’s liquidity, leverage, growth, margins, profitability, rates of return, valuation, and more.

4. Ratio analysis is a process used for the calculation of financial ratios or in other words, for the purpose of evaluating the financial wellbeing of a company. The values used for the calculation of financial ratios of a company are extracted from the financial statements of that same company. Ratio analysis can be defined as the process of ascertaining the financial ratios that are used for indicating the ongoing financial performance of a company using few types of ratios such as liquidity, profitability, activity, debt, market, solvency, efficiency, and coverage ratios and few examples of such ratios are return on equity, current ratio, quick ratio,  dividend payout ratio , debt-equity ratio, and so on.

5. Classification of Accounting Ratio Types of ratios are given below: Liquidity Ratios Leverage Ratio Turnover Ratio Profitability Ratio

6. Liquidity Ratios This type of ratio helps in measuring the ability of a company to take care of its short-term debt obligations. A higher liquidity ratio represents that the company is highly rich in cash. The types of liquidity ratios are: – Current Ratio or Working Capital Ratio Quick Ratio or Liquidity Ratio or Acid Test Ratio Absolute Liquid Ratio or Cash Ratio Stock to Working Capital Ratio

7. 1. Current Ratio:   The current ratio is the ratio between the current assets and current liabilities of a company. The current ratio is used to indicate the liquidity of an organization in being able to meet its debt obligations in the upcoming twelve months. A higher current ratio will indicate that the organization is highly capable of repaying its short-term debt obligations. Current Ratio = Current Assets / Current Liabilities Current Assets: Current Assets means cash and those assets which can be converted into cash within one year in ordinary course of business. Current Liabilities: Current Liabilities are those which are to be paid by the firm in one year.  

8. Current Ratio:   Current Ratio = Current Assets / Current Liabilities Interpretation of Current Ratio: Standard or Ideal Current Ratio is 2:1 If current ratio is less than the standard ratio of 2:1, it indicates that the concern does not enjoy the sufficient liquidity and shortage of working capital. If current ratio is more than the standard ratio of 2:1, it indicates that the concern has sufficient liquidity.  

9. 2. Quick Ratio or Liquidity Ratio or Acid Test Ratio : The quick ratio is used to ascertain information pertaining to the capability of a company in paying off its current liabilities on an immediate basis. The formula used for the calculation of a quick ratio is- Quick Ratio = (Cash and Cash Equivalents + Marketable Securities + Accounts Receivables) / Current Liabilities . Liquid/Quick Assets: Liquid/ Quick Assets means cash and those assets which can be converted into cash within a short period. Liquid/Quick Liabilities: Liquid/Quick Liabilities are those which are to be paid by the firm in short period. Quick  

10. Liquid/Quick Ratio:   Interpretation of Liquid/Quick Ratio: Standard or Ideal Current Ratio is 1:1 If Liquid/Quick ratio is less than the standard ratio of 1:1, it indicates that the concern does not enjoy the sufficient liquidity and shortage of working capital. If Liquid/Quick ratio is more than the standard ratio of 1:1, it indicates that the concern has sufficient liquidity.

11. Liquid/Quick Assets I Current Investments Marketable Securities II Trade Receivable Sundry Debtors Bills Receivable III Cash & Cash Equivalent Cash Cash at Bank IV Short Term Loans & Advances Loans & Advances to Staff Money at call or short notice V Other Current Assets Outstanding Incomes

12. Liquid/Quick Liabilities I Short Term Borrowings Short Term Loans & Advances Deposits (Cr.) II Trade Payable Sundry Creditors Bills Payable III Other Current Liabilities Income tax payable Excise duty or VAT payable Outstanding expenses Income received in advance Unclaimed dividend Interest due or payable Instalment payment on long term loans IV Short Term Provisions Provisions for taxation Proposed dividend Provisions for salaries, wages, bonus etc ( i.e , long term loan due for payment in current year is current liability) Any amount payable in short period The current ratio measures its short term solvency i.e , its ability to meet short term obligations. Quick Liabilities: do not include bank overdraft and cash credit.  

13. 3. Absolute Liquid Ratio or Cash Ratio: The  cash ratio  measures a company’s ability to pay off short-term liabilities with cash and cash equivalents: Cash ratio = Cash and Cash equivalents / Current Liabilities A  

14. Absolute Liquid Ratio or Cash Ratio :   Interpretation of Absolute Liquid Ratio or Cash Ratio : Standard or Ideal Current Ratio is 1:2 If Absolute Liquid Ratio or Cash Ratio is less than the standard ratio of 1:2, it indicates that the concern does not enjoy the sufficient liquidity and shortage of working capital. If Absolute Liquid Ratio or Cash Ratio is more than the standard ratio of 1:2, it indicates that the concern has sufficient liquidity.

15. Absolute Liquid Assets I Current Investments Readily Marketable Securities II Cash & Cash Equivalent Cash Cash at Bank Quick Liabilities: do not include bank overdraft and cash credit.  

16. Liquid/Quick Liabilities I Short Term Borrowings Short Term Loans & Advances Deposits (Cr.) II Trade Payable Sundry Creditors Bills Payable III Other Current Liabilities Income tax payable Excise duty or VAT payable Outstanding expenses Income received in advance Unclaimed dividend Interest due or payable Instalment payment on long term loans IV Short Term Provisions Provisions for taxation Proposed dividend Provisions for salaries, wages, bonus etc ( i.e , long term loan due for payment in current year is current liability) Any amount payable in short period The current ratio measures its short term solvency i.e , its ability to meet short term obligations.

17. 4. Stock to Working Capital Ratio: It is calculated by dividing the value of stock (or inventories such as raw materials, work in progress, finished goods, stores and packing materials) by the Working capital. S * 100   N   S * 100   Standard is 75% of working capital

18. Stock to Working Capital Ratio :   Interpretation of Absolute Liquid Ratio or Cash Ratio : Standard is 75% of working capital If inventory consumed is less than 75% of working capital, it indicates it is that high liquid position. If inventory consumed is more than 75% of working capital, it indicates it is that low liquid position.

19. From the following information of X Co. Ltd. Calculate: a) Current Assets, b) Quick Assets, c) Inventory (Stock) Current Ratio = 3:1, Liq uid Ratio = 2:1, Working Capital = Rs.1,20,000   Solution:     Current Ratio = 3:1 Liquid Ratio = 2:1 Working Capital = Current Assets – Current Liabilities = Rs. 1,20,000      

20. From the following information of X Co. Ltd. Calculate: a) Current Assets, b) Quick Assets, c) Inventory (Stock) Current Ratio = 3:1, Liq uid Ratio = 2:1, Working Capital = Rs.1,20,000 =   Solution: Current Assets = 3 & Current Liabilities = 1 Working Capital = Current Assets – Current Liabilities Working Capital = 3 – 1 Working Capital =2 For, Working Capital 2 ……. 1,20,000 Current Assets 3 ……. ? Working Capital = Current Assets – Current Liabilities Current Liabilities = Current Assets – Working Capital = 1,80,000 – 1,20,000 = 60,000     * 1,20,000 =   = 2:1 =   Liquid Assets = 3 & Current Liabilities = 1 For, Current Liabilities 1 ……. 60,000 Liquid Assets 2 ……. ? Liquid Assets = Current Assets - Stock Stock = Current Assets – Liquid Assets = 1,80,000 – 1,20,000 = 60,000 * 60,000 =   Current Assets = 1,80,000 Quick Assets = 1,20,000 Stock = 60,000

21. From the following information , Calculate: a) Current Assets, b) Current Liabilities, c) Stock Turnover Ratio Current Ratio = 3:1, Liq uid Ratio = 2:1, Working Capital = Rs.1,20,000 Working Capital = Rs. 75,000 Current Ratio = 2.5:1 Net Sales = Rs.4,80,000 Opening Stock = Rs. 24,500 Closing Stock = Rs. 35,000 Gross profit ratio = 25% on Sales

22. Compute Sales from the following : Current Ratio = 2:1, Liq uid Ratio = 1.5:1, Current Liabilities= Rs.4,00,000 Inventory turnover ratio = 9 times =   Current Assets = 2 & Current Liabilities = 1 For, Current Liabilities 1 ……. 4,00,000 Current Assets 2 ……. ? Solution: * 4,00,000 =     = 1.5:1 =   Liquid Assets = 1.5 & Current Liabilities = 1 For, Current Liabilities 1 ……. 4,00,000 Liquid Assets 1.5 ……. ? * 4,00,000 =   Calculation of Current Assets : Calculation of Liquid Assets :

23.   Sales = Inventory Ratio * Average Stock = 9 * 2,00,000 = 18,00,000 Calculation of Stock: Calculation of Sales:   Liquid Assets = Current Assets - Stock Stock = Current Assets – Liquid Assets = 8,00,000 – 6,00,000 = 2,00,000   Answers : Current Assets = 8,00,000 Quick Assets = 6,00,000 Stock = 2,00,000 Sales = 18,00,000

24. Calculate Current Ratio & Liquid Ratio from the following : Cash = Rs.10,000, Bank Overdraft = Rs.30,000, Creditors = Rs. 30,000, Bank = Rs. 20,000, B/R = Rs.50,000, B/P = Rs. 20,000, Book Debts = Rs. 1,00,000, Stock = Rs.1,00,000   Current Assets = Cash + Bank + B/R + Book Debts + Stock = 10,000 + 20,000 + 50,000 + 1,00,000 + 1,00,000 = 2,80,000 Current Liabilities = Bank OD + Creditors + B/P = 30,000 + 30,000 + 20,000 = 80,000 Solution:   Liquid Assets = Cash + Bank + B/R + Book Debts = 10,000 + 20,000 + 50,000 + 1,00,000 = 1,80,000 Current Liabilities = Creditors + B/P = 30,000 + 20,000 = 50,000 Calculation of Current Ratio : Calculation of Liquid Ratio : = 3.5 :1   = 3.6 :1  

25. You are given: Current Ratio = 2.8:1, Acid Test Ratio = 1.5:1, Working Capital = 1,62,000 Find out: a) Current Assets, b) Current Liabilities, c) Liquid Assets   Solution:  

26. = 2.8:1 =   Solution: Current Assets = 2.8 & Current Liabilities = 1 Working Capital = Current Assets – Current Liabilities Working Capital = 2.8 – 1 Working Capital =1.8 For, Working Capital 1.8 ……. 1,62,000 Current Assets 2.8 ……. ? Working Capital = Current Assets – Current Liabilities Current Liabilities = Current Assets – Working Capital = 2,52,000 – 1,62,000 = 90,000     * 1,62,000 =   = 1.5 :1 =   Liquid Assets = 1.5 & Current Liabilities = 1 For, Current Liabilities 1 ……. 90,000 Liquid Assets 1.5 ……. ? * 90,000 =   Current Assets = 2,52,000 Current Liabilities = 90,000 Liquid Assets = 1.35,000 You are given: Current Ratio = 2.8:1, Acid Test Ratio = 1.5:1, Working Capital = 1,62,000 Find out: a) Current Assets, b) Current Liabilities, c) Liquid Assets Calculation of Current Assets & Current Liabilities: Calculation of Liquid Assets :

27. From the following information given: Current Ratio = 3:1, Acid Test Ratio = 2:1, Current Liabilities = Rs. 50,000 Find out: a) Current Assets, b) Liquid Assets, c) Inventory   Solution:    

28. The liquidity position of two firms are given below:   Solution:   A Ltd. (Rs.) B Ltd. (Rs.) Cash 10,000 20,000 Debtors 50,000 85,000 Inventory 1,00,000 70,000 Total Current Assets 1,60,000 1,75,000 Total Current Liabilities 80,000 1,00,000 Calculate current ratio and acid test ratio.

29.   Solution: A Ltd. (Rs.) B Ltd. (Rs.) Cash 10,000 20,000 Debtors 50,000 85,000 Inventory 1,00,000 70,000 Total Current Assets 1,60,000 1,75,000 Total Current Liabilities 80,000 1,00,000 Calculate current ratio and acid test ratio. Calculation of Current Ratio: Current Assets = Cash + Debtors + Stock = 10,000 + 50,000 + 1,00,000 = 1,60,000 Current Liabilities = 80,000   Liquid Assets = Cash + Debtors = 10,000 + 50,000 = 60,000 Current Liabilities = 80,000 Calculation of Liquid Ratio : = 2 :1   = 0.75 :1   A Ltd : Current Assets = Cash + Debtors + Stock = 20,000 + 85,000 + 70,000 = 1,75,000 Current Liabilities = 1,00,000 = 1.75 :1   B Ltd : A Ltd : B Ltd : Liquid Assets = Cash + Debtors = 20,000 + 85,000 = 1,05,000 Current Liabilities = 1,00,000 = 1.05 :1  

30. Thank You