Liquidity Ratios

Financial ratios are designed to assist on analyze a financial statement. From an investors' perspective, financial statement analysis is important for predicting the future outcomes of the company. While from management's standpoint, it useful to anticipate future conditions and a starting point for planning and actions that will affect the future course of events.

Liquidity ratios show the relationship of a firm's cash and other current assets to its current liabilities. It relates to the ability to meet short-term obligations, that is also called current ratio. To compute the current ratio:

Current ratio
= Current assets / Current liabilities
= RM1,000/ RM310
=3.2 times, if the industry average 4.2 times;weak

Current assets are normally inclusive of cash, marketable securities, accounts receivable and inventories. While current liabilities, consist of account payable, short term notes payable, current maturities of long term debt, accrued taxes and other accrued expenses.

Under the liquidity ratios, we have also acid test ratio, that is calculated by deducting inventories from current assets and dividing the remainder by current liabilities. This is because inventories are typically the least liquid of a company's current assets.

Acid test ratio
= Current assets - Inventories / Current liabilities
= RM385/ RM310
= 1.2 times, if the industry average 2.2 times;weak

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