Ratio Analysis (liquidity ratio)

Ratio Analysis..

"Ratio is a simple arithematical expression of the relationship of one number to another.It is obtained by dividing the former by later .It express relationship of items of financial statements."

Classification of Ratios..

1)Liquidity or Short term solvency ratios-These ratio analysis the short term financial position of business.It represents the firm ability to meet it's current financial obligations.

😊Current Ratio-This ratio express the relationship between current assets and current liabilities it is also known as working Capital 

ratio, its ideal ratio  is 2:1.

   Current Ratio=__Current Assets

                               Current Liabilities

Current Assets are those assets which can be converted into cash within a period of one year .

              Current Assets are 👇

I)Cash and Bank balance

ii)Debtors

III)Bills Receivable

iv)Stock

v)Short -term investment or marketable securities

vi) Prepaid Expenses

vii)Advance Payment

viii)Accrued income

    

    Current Liabilities are those liabilities which are to be paid within a period of one year out of current Assets .

              Current Liabilities are👇

I) Creditors

ii)Bills Payable

III)Bank Overdraft

iv)Short term loans

v) Outstanding Expenses

vi) Income Tax payable

vii) Unclaimed Dividend

viii) Provision for Tax

ix) Proposed Dividend

      Current Ratio of a firm measures it's short term solvency means firm ability to pay it's short term obligations which are due.for eg .if current Assets of firm is 40,00000 and its current Liabilities is 20,00000 current Ratio is 2:1 it means firms current assets is double of its current liabilities means firm is able to pay it's current Liabilities in full margin of safety to short term creditors.if the current Ratio is  higher it is good from the Creditors point of view but extremely high current Ratio is not good from management point of view because it indicates •more funds of the firm invested into unproductive uses(inventory)which do not have return.

•it show poor investment Policy.

•poor credit management due to over extended accounts receivable.

   A low &declining current ratio it indicates

• inadequate margin of safety to the Creditors or no sufficient cash available.

• shortage of working Capital in the business for day to day transactions.
    
    

Liquidity or Quick Ratio...

    This ratio show the instant paying capacity of business debts ,it means how  fast can business pay off its current liabilities from their liquid assets within a period of 1-2months ,that is why this also known as acid test ratio, quick ratio.This ratio established relationship between quick/liquid assets and current Liabilities.

     

            

    Liquidity or Quick Ratio=Prepaid Expenses

                         Liquid or Quick Assets

                       Current liabilities

Current Assets

I)Cash and Bank balance

ii)Debtors

III)Bills Receivable

iv)StockPrepaid Expenses

v)Short -term investment or marketable securities

vi) Prepaid Expenses

vii)Advance Payment

viii)Accrued income

    All these current Assets are liquid assets except stock and prepaid expenses because  all these assets except (stock and prepaid expenses) can converted into cash within 1-2months to pay off its current Liabilities but from  Stock and  Prepaid Expenses we cannot get cash quickly because stock may not be sale within 1-2month and we cannot get cash back from our pre paid expenses so these assets are excluded from current assets.Its ideal ratio is 1:1.If business have 1:1 its quick ratio it indicates sound financial position..It means business can easily pay off its current liabilities from its quick Assets without any difficulty.

Absolute Liquidity Ratio..

 Meaning- Absolute Liquidity Ratio show more liquidity than current ratio and quick ratio that is why it is known as Absolute Liquidity Ratio.It shows the relationship between absolute liquid assets to quick liabilities formula..

   

Absolute Liquidity Ratio=

                           =Absolute liquid Assets

                             Quick & Liquid Liabilities

  In Absolute Liquidity Ratio we take those assets which can be converted into cash within few days for pay liquid liabilities and in liquid liabilities we include those all current liabilities which can be paid immediately .

Absolute & Quick Assets are 

😊Cash

😊Bank

😊 Marketable securities.

🖋️ Debtors and receivable are not included in Absolute liquid Assets because these assets take time to converted into cash .

🖋️All current liabilities are liquid liabilities except bank overdraft as it is not to be paid immediately.

 A standard ideal ratio in Absolute Liquidity Ratio is 0.5:1 it means fifty Paisa of absolute liquid assets are sufficient for one rupee worth of liquid liabilities.