Liquidity Ratios

Liquidity ratios asses a businesss liquidity, i.e. its ability to convert its assets to cash and pay off
its obligations without any significant difficulty (i.e. delay or loss of value). Liquidity ratios are
particularly useful for suppliers, employees, banks, etc. Important liquidity ratios are:

Current Ratio
Current ratio is one of the most fundamental liquidity ratio. It measures the ability of a business
to repay current liabilities with current assets.
Formula
Current ratio is calculated using the following formula:

Current Assets
Current Ratio =
Current Liabilities

Quick Ratio
Quick ratio is most useful where the proportion of illiquid current assets to total current assets is
high. However, quick ratio is less conservative than cash ratio, another important liquidity
parameter.
Formula
The following is the most common formula used to calculate quick ratio:
Cash + Marketable Securities + Receivables
Quick Ratio
Current Liabilities

Cash Ratio
Cash ratio is the ratio of cash and cash equivalents of a company to its current liabilities. It is an
extreme liquidity ratio since only cash and cash equivalents are compared with the current
liabilities. It measures the ability of a business to repay its current liabilities by only using its
cash and cash equivalents and nothing else.
Formula
Cash ratio is calculated using the following formula:
 Cash + Cash Equivalents
Cash Ratio =
Current Liabilities
Cash equivalents are assets which can be converted into cash quickly whereas current liabilities
are those liabilities which are to be settled within 12 months or the business cycle.

Activity Ratios

Activity ratios assess the efficiency of operations of a business. For example, these ratios attempt
to find out how effectively the business is converting inventories into sales and sales into cash, or
how it is utilizing its fixed assets and working capital, etc. Key activity ratios are:

Inventory Turnover Ratio

Inventory turnover is an efficiency ratio which calculates the number of times per period a
business sells and replaces its entire batch of inventories. It is the ratio of cost of goods sold by a
business during an accounting period to the average inventories of the business during the
period.
Dividing the total cost of inventories sold during a period (which equals cost of goods sold) by
the cost of average inventories balance maintained by a business gives us dollars of sales made
per dollar of cash tied up in inventories.
Formula
Inventory turnover ratio is calculated using the following formula:
Cost of Goods Sold
Inventory Turnover =
Average Inventories

Accounts Receivable Turnover Ratio

Accounts receivable turnover is the ratio of net credit sales of a business to its average accounts
receivable during a given period, usually a year. It is an activity ratio which estimates the number
of times a business collects its average accounts receivable balance during a period.
Formula
Accounts receivable turnover is calculated using the following formula:
Receivables Net Credit Sales
=
Turnover Average Accounts Receivable

Average Collection Period

Average collection period is computed by dividing the number of working days for a given
period (usually an accounting year) by receivables turnover ratio. It is expressed in days and is
an indication of the quality of receivables.

The formula is given below:

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.

PROFITABILITY RATIOS
Profitability ratios are a class of financial metrics that are used to assess a business's ability to
generate earnings compared to its expenses and other relevant costs incurred during a specific
period of time. For most of these ratios, having a higher value relative to a competitor's ratio or
relative to the same ratio from a previous period indicates that the company is doing well.

Operating Profit Ratio:

Operating net profit ratio is calculated by dividing the operating net profit by sales. This ratio
helps in determining the ability of the management in running the business.
Formula:
Operating profit ratio = (Operating profit / Net sales) 100

NET PROFIT RATIO

Net profit is not an indicator of cash flows, since net profit incorporates a number of non-cash
expenses, such as accrued expenses, amortization, and depreciation.

The formula for the net profit ratio is to divide net profit by net sales, and then multiply by 100.
The formula is:

NET PROFIT RATIO = NET PROFIT AFTER TAX X 100

NETSALES

LONG TERM SOLVENCY RATIOS

A key metric used to measure an enterprises ability to meet its debt and other obligations.
The solvency ratio indicates whether a companys cash flow is sufficient to meet its short-term
and long-term liabilities. The lower a company's solvency ratio, the greater the probability that it
will default on its debt obligations.

DEBT-EQUITY RATIO
Debt/Equity Ratio is a debt ratio used to measure a company's financial leverage, calculated by
dividing a companys total liabilities by its stockholders' equity. The D/E ratio indicates how
much debt a company is using to finance its assets relative to the amount of value represented in
shareholders equity.
The formula is:
DEBT-EQUITY RATIO= LOANS /SHAREHOLDERS FUND

INTEREST COVERAGE RATIO

The interest coverage ratio is a debt ratio and profitability ratio used to determine how easily a
company can pay interest on outstanding debt. The interest coverage ratio may be calculated by
dividing a company's earnings before interest and taxes (EBIT) during a given period by the
amount a company must pay in interest on its debts during the same period.
The method for calculating interest coverage ratio may be represented with the following
formula:
The formula is: