Liquidity ratio

A financial ratio is very important in fundamental analysis, of which there is a liquidity ratio that we will know about today.

Liquidity ratios

Liquidity ratios are the ratios that measure the ability of a company to pay off its short-term liabilities without raising external capital.

If we say it in simple terms, then liquidity ratios tell us whether the company is capable of repaying the current liability by selling its existing assets.

Types of liquidity ratios

liquidity ratios are divided into 8 part, Which we can see here

1. Current ratio5. Cash to working capital ratio
2. Cash ratio6. Inventory to working capital ratio
3. Quick ratio7. Sales to working capital ratio
4. Working capital ratio8. Sales to current asset ratio

Before knowing all these liquidity ratios, we want to tell some financial terms so that you can understand it easily.

Current assets

A current asset, also known as a short-term asset, is a resource used to pay short-term payables. In other words, the assets of the company which can be converted into cash within 12 months are called the current assets of the company. Current assets appear on a company’s balance sheet

Example- Cash and cash equivalent, Inventory, Pre-paid expenses, Account receivable, Marketable securities, Ongoing projects

current assets
picture is credit ti Byju’s

a-Cash & cash equipments

A company held cash in reserve or deposited in the company’s bank account is called cash and cash instruments.

b- Inventory

Inventory is the term for the goods available for sale and raw material

Example- Some example of inventory which you can see below

  1. Raw materials
  2. Working progress
  3. Finished goods

c-Pre-paid expenses

When a company pays in advance to buy goods ( raw materials etc) used to make a product, then we add the payments to current assets.

d-Acount receivable-

When the product of a company is delivered to the customer but its payment is not made immediately, that is, it is payable in the installment, then we keep that amount in the category of account receivable.

The companies reach their product to the customer through a shopkeeper, store, supermarket, or distributor who takes the product from the company on credit which we call as account receivable.

e-Marketable securities-

Market securities are investments that can easily be bought, sold, or traded on a public exchange like mutual funds investments, share market investments, and gold investments, etc

Investment in stock market, mutual funds or gold etc. by a company is called market securities.

f-Ongoing projects-

When a company is working on a product to make it i.e. work in progress, then it is known as Ongoing Projects.

Current Liabilities-

A current liability is an obligation payable within one year. Current liability appear on a company’s balance sheet

Example- Long-term liabilities installment, Account payable, Dividends payable, Income Taxes payable, Bank account overdraft, Advance from customers, outstanding expenses

a-Long-term liability installment-

When a company takes a loan from a financial institution for the long term, then that company has to pay an installment every month to repay the loan, which we keep in the category of current ratio

b-Account payable-

When a company purchases goods on credit that need to be paid back in a short time period (within 1 year), it is known as accounts payable.

c-Dividends payable-

Dividend payable is the portion of accumulated profits that are declared to be paid as dividends by the company’s board of directors.

d-Income Taxes payable

The tax paid by the company to the government is called Income Taxes payable.

e-Bank account overdraft-

Bank account overdraft occurs when a person or company’s bank account balance drops below zero, resulting in a negative balance. This usually happens when the account does not have much money in the account, but an outstanding transaction is processed through the account,  leading to the account holder incurring a debt.

f-Advance from customers

When a company takes money in advance to deliver a product from a customer, it is kept in this category

g-Outstanding expenses-

Room rent, Light bill, workers wages, etc

This was some very important information to tell you, before starting the financial ratio In the next post we will cover the topic of liquidity ratios of financial ratio.

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