Unit 3 Working With Financial Statements G2

Ratio Analysis & Liquidity

Ratio Analysis

Uses relationships between financial statement numbers to evaluate and compare a company's financial performance.

Why Financial Ratios Are Useful

They help compare companies, identify trends over time, and highlight strengths and weaknesses.

Five Categories of Financial Ratios

Liquidity, long-term solvency, asset management/turnover, profitability, and market value.

Liquidity Ratios

Measure a firm's ability to meet its short-term financial obligations.

Liquidity Trade-Off

More liquidity makes it easier to pay obligations but can create opportunity costs because cash and other liquid assets may earn lower returns.

Current Ratio Formula

Current Assets ÷ Current Liabilities.

Current Ratio Meaning

Measures the extent to which current assets can cover current liabilities.

Current Ratio Interpretation

A current ratio of 1.13 means the company has $1.13 of current assets for every $1 of current liabilities.

Quick Ratio Formula

(Current Assets − Inventory) ÷ Current Liabilities.

Quick Ratio Meaning

Measures the ability to pay short-term obligations without relying on selling inventory.

Why Inventory Is Removed From the Quick Ratio

Inventory is typically the least liquid current asset.

Cash Ratio Formula

Cash ÷ Current Liabilities.

Cash Ratio Meaning

Measures how much of current liabilities could be covered using cash alone.

Net Working Capital (NWC) Formula

Current Assets − Current Liabilities.

NWC to Total Assets Formula

Net Working Capital ÷ Total Assets.

Interval Measure Formula

Current Assets ÷ Average Daily Operating Costs.

Interval Measure Meaning

Estimates how many days a company could operate using its current assets without additional cash inflows.

Average Daily Operating Costs

Annual operating costs ÷ 365