Analysis of Financial Statements - Liquidity Ratios
3 important questions on Analysis of Financial Statements - Liquidity Ratios
How could current ratio fall?
If a company is having financial difficulty, it typically begins to pay its accounts payable more slowly and borrow more from its bank. --> increase current liabilities.
If current liabilities are rising faster than current assets, the current ratio will fall, and this is a sign of possible trouble.
If current liabilities are rising faster than current assets, the current ratio will fall, and this is a sign of possible trouble.
What does a high current ratio indicate?
The extent to which current liabilities are covered by those assets expected to be converted to cash in the near future.
A strong safe liquidity position
or
the firm has too much old inventory that will have to be written off and too many old accounts receivable that may turn into bad debts.
Or it has too much cash, receivables, and inventory relative to its sales, in which case these assets are not being managed efficiently.
A strong safe liquidity position
or
the firm has too much old inventory that will have to be written off and too many old accounts receivable that may turn into bad debts.
Or it has too much cash, receivables, and inventory relative to its sales, in which case these assets are not being managed efficiently.
Why are inventories deducted in the quick ratio?
Inventories are typically the least liquid of a firm;s current assets, and if sales slow down, they might not be converted to cash as quickly as expected.
Also, inventories are the assets on which losses are more likely to occur in the event of liquidation.
Therefore, the quick ratio, which measures the firm's ability to pay off short-term obligations without relying on the sale of inventories, is important.
Also, inventories are the assets on which losses are more likely to occur in the event of liquidation.
Therefore, the quick ratio, which measures the firm's ability to pay off short-term obligations without relying on the sale of inventories, is important.
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