LIQUIDITY RATIOS:

CURRENT RATIO:
The current ratio is a liquidity ratio that measures a company's ability to pay short-term
and long-term obligations. To gauge this ability, the current ratio considers the current total
assets of a company (both liquid and illiquid) relative to that company’s current total liabilities.
The formula for calculating a company’s current ratio is:

Current Ratio = Current Assets / Current Liabilities

The current ratio is called “current” because, unlike some other liquidity ratios, it
incorporates all current assets and liabilities.The current ratio is also known as the working
capital ratio.

Advantages of Current Ratio

 Current ratio helps in understanding how cash rich a company is. It helps us gauge the
short-term financial strength of a company. Higher the ratio, more stable the company is.
Lower the ratio, greater is the risk of liquidity associated with the company.
 The current ratio gives an idea of a company’s operating cycle. It helps in understanding
how efficient the company is in selling off its products; that is, how quickly is the
company able to convert its inventory or current assets into cash. Knowing this, a
company can optimize its production. This enables the company to plan inventory storage
mechanisms and optimize the overhead costs.
 Current ratio shows the management’s efficiency in meeting the creditor’s demands. It
also gives an understanding of working capital management/requirement of the company.

Disadvantages of Current Ratio

 Using this ratio on a standalone basis may not be sufficient to analyze the liquidity
position of the company as it relies on the amount of current assets instead of the quality
of the asset.
 Current ratio includes inventory in the calculation, which may lead to overestimation of
the liquidity position in many cases. In companies, where higher inventory exists due to
fewer sales or obsolete nature of the product; taking inventory under calculation may lead
to displaying incorrect liquidity health of the company.
 In companies where sales are seasonal; current ratio may show lower numbers in some
months and higher current ratio in the other.
 Current Ratio may be impacted due to change in inventory valuation methodology by the
company. Such will not be a case while using the quick ratio since it does not consider
inventory at all.
 An equal increase or decrease in the current assets and current liabilities can change the
ratio. Hence, an overdraft against inventory can cause the current ratio to change. Hence,
it is very easy to manipulate current ratio.
QUICK RATIO:

The quick ratio is an indicator of a company’s short-term liquidity, and measures a company’s
ability to meet its short-term obligations with its most liquid assets. Because we're only
concerned with the most liquid assets, the ratio excludes inventories from current assets. Quick
ratio is calculated as follows:

Quick ratio = (current assets – inventories) / current liabilities

OR
Quick ratio = (cash and equivalents + marketable securities + accounts receivable) / current
liabilities.The quick ratio is also known as the acid-test ratio.

Advantages of Quick Ratio:

 Best advantages of quick ratio compare to others liquidity ratios especially current ratio is
that this ratio help to measure how well current assets pay off current liabilities more
accurately. The calculation of quick ratio, we use only the most liquid assets that could
transform into cash quickly or even become cash already to calculate. That mean these
kind of assets take very short times to become cash when the current liabilities are quire
to pay off.
 As mention above, this ratio exclude inventories from its calculation. As we know,
inventories could talk long time to convert into cash. It is depending on the types of the
business and market that entity operating in. Some inventories take a day to convert into
cash, some require months or even more than one year. Eliminate it from its the ratio
could help management, share investors, shareholders, and others stakeholders to have
better information to assess the entity’s liquidity position.
 Another advantages of quick ratio is that this ratio is very easy to understand and straight
forward. It can help the users of ratio who doe not have deep skill in accounting and
financial to understand this ratio easily. For example, some of operation managers who
their KPI are including quick ratio could see and understand the ratio.
 This ratio is measure as the percentages. So if the ratio is higher than the target, that mean
some actions are required to fix.
 Set as KPI and compare its with different size of entity. This ratio compare current assets
and current liabilities and the result measure as percentages. That mean we can compare
it to the others entity or competitors which have different size and nature.

Disadvantages of Quick Ratio:

Although quick ratio has some advantages, its also has certain disadvantages that the users
especially the specialist who is responsible for analyst and interpret this ratio should be aware of.
Here are those disadvantages of quick ratio:

 It is the financial indicator. As we know this ratio use the financial information to analyst
the liquidity position of entity. This financial information could be influence by
management of entity if they want. Maybe they could influence by accounting policies or
factitious the financial information.
  It use the past data to predict the future. Quick ratio is assess how entity could pay off the
current liabilities by using current assets now and in the future. This is probably not help
users to get their objective more accurately. For example, even the entity has the poor
ratio, but the management team have a very credit and relationship with the banks or even
with the suppliers. They might solve this problem better than the entity that have good
ratio.
 high ratio does not always good. For example, the entity has 1.5 quick ratio at 31
December 2016. Based on the explanation above, the entity has the very good ratio. But
what if the entity require to pay off the high amount of loan in the months 13th. From
accounting perspective, this 13 months loan treat as long term liabilities as at 31
December 2016. But in the month of January 2017, that 13 months become current
liabilities and subsequently affect the quick ratio just a month after valuation (31
December 2016). So, this ratio might lead the users to make wrong decision.

ABSOLUTE LIQUID RATIO:

The relationship between the absolute liquid assets and current liabilities is established by
this ratio. Absolute Liquid Assets take into account cash in hand, cash at bank, and
marketable securities or temporary investments. The most favourable and optimum value
for this ratio should be 1: 2. It indicates the adequacy of the 50% worth absolute liquid
assets to pay the 100% worth current liabilities in time. If the ratio is relatively lower than
one, it represents the company’s day-to-day cash management in a poor light. If the ratio
is considerably more than one, the absolute liquid ratio represents enough funds in the
form of cash in order to meet its short-term obligations in time.
INVENTORY TURNOVER RATIO:
Inventory turnover is a ratio showing how many times a company's inventory is sold
and replaced over a period of time. The days in the period can then be divided by the
inventory turnover formula to calculate the days it takes to sell the inventory on hand. It
is calculated as sales divided by average inventory.
Absolute liquid ratio=Absolute liquid assests/current liabilities
Liquid assests=current assests-(stock + prepaid expences)
RECEIVABLE TURN OVER RATIO:
The receivables turnover ratio is an accounting measure used to quantify a firm's effectiveness
in extending credit and in collecting debts on that credit. The receivables turnover ratio is
an activity ratio measuring how efficiently a firm uses its assets.

Receivables turnover ratio can be calculated by dividing the net value of credit sales during a
given period by the average accounts receivable during the same period. Average accounts
receivable can be calculated by adding the value of accounts receivable at the beginning of the
desired period to their value at the end of the period and dividing the sum by two.The method for
calculating receivables turnover ratio can be represented with the following formula:
Accounts Receivable Turnover= Net credit sales/Average Accounts Receivable

The receivables turnover ratio is most often calculated on an annual basis, though it can also be
calculated on a quarterly or monthly basis .Receivable turnover ratio is also often called accounts
receivable turnover, the accounts receivable turnover ratio, or the debtor’s turnover ratio.

PAYABLE TURNOVER RATIO:

The accounts payable turnover ratio is a short-term liquidity measure used to quantify the rate at
which a company pays off its suppliers. Accounts payable turnover ratio is calculated by taking
the total purchases made from suppliers, or cost of sales, and dividing it by the average accounts
payable amount during the same period.

Accounts Payable Turnover=Total Supplier Purchases/Average Accounts Payable

WORKING CAPITAL TURNOVER RATIO:

Working capital turnover is a measurement comparing the depletion of working capital

used to fund operations and purchase inventory, which is then converted into sales revenue for
the company. The working capital turnover ratio is used to analyze the relationship between the
money that funds operations and the sales generated from these operations. For example, a
company with current assets of $10 million and current liabilities of $9 million has $1 million in
working capital, which may be used in fundamental analysis.

Working Capital Turnover=Sales/Working capital