Liquidity Measurement Ratios
The first ratios we’ll take a look at are the liquidity ratios. Liquidity ratios attempt to measure a company’s ability to pay off its short-term debt obligations. This is done by comparing a company’s most liquid assets (or, those that can be easily converted to cash) and its short- term liabilities.
In general, the greater the coverage of liquid assets to short-term liabilities, the better it is, since it is a clear signal that a company can pay debts that are going to become due in the near future and it can still fund its on-going operations. On the other hand, a company with a low coverage rate should raise a red flag for the investors as it may be a sign that the company will have difficulty meeting running its operations, as well as meeting its debt obligations.
The biggest difference between each ratio is the type of assets used in the calculation. While each ratio includes current assets, the more conservative ratios will exclude some current assets as they aren’t as easily converted to cash. The ratios that we’ll look at are the current, quick and cash ratios and we will also go over the cash conversion cycle, which goes into how the company turns its inventory into cash.
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