Liquidity Ratios Overview

Liquidity Ratios

• Current Ratio

  • Formula: Current Assets / Current Liabilities
  • Significance: Measures a company's ability to cover its short-term obligations with its short-term assets.

• Quick Ratio

  • Formula: (Cash + Short-term Marketable Investments + Receivables) / Current Liabilities
  • Significance: Evaluates the liquidity of a company by measuring its ability to cover current liabilities without selling inventory.

• Cash Ratio

  • Formula: Cash + Short-term Marketable Investments / Current Liabilities
  • Significance: Indicates a company's ability to pay off its current liabilities using only cash and cash equivalents.

• Defensive Interval Ratio

  • Formula: (Cash + Short-term Marketable Investments + Receivables) / Daily Cash Expenditures
  • Significance: Measures how long a company can sustain its daily operations using liquid assets without any incoming cash flow, similar to the burn rate for startups.

• Cash Conversion Cycle

  • Formula: Days Inventory Held (DOH) + Days Sales Outstanding (DSO) - Days Payables Outstanding
  • Significance: Represents the time taken to convert investments in inventory and accounts receivable into cash flows from sales.

Notes on Components

• Numerator Components:

  • Current Assets: Total assets that are expected to be converted into cash within one year.
  • Cash + Short-term Marketable Investments: Liquid assets that can be quickly converted to cash.
  • Receivables: Money owed to the company for credit sales, which is collectible within short term.

• Denominator Components:

  • Current Liabilities: Obligations that must be settled within the company's operating cycle or one year, whichever is longer.