liquidity ratio

(noun)

total cash and equivalents divided by short-term borrowings

Related Terms

Examples of liquidity ratio in the following topics:

  • Liquidity Ratios

    • Liquidity ratios measure how quickly assets can be turned into cash in order to pay the company's short-term obligations.
    • Liquidity ratios measure a company's ability to pay short-term obligations of one year or less (i.e., how quickly assets can be turned into cash).
    • A high liquidity ratio indicates that a business is holding too much cash that could be utilized in other areas.
    • A low liquidity ratio means a firm may struggle to pay short-term obligations.
    • This ratio reveals whether the firm can cover its short-term debts; it is an indication of a firm's market liquidity and ability to meet creditor's demands.

  • Sample Evaluation

    • BEP Ratio = EBIT / Total Assets = 1,810/13,840 = 0.311
    • This demonstrates that the company does not seem to be in a tight position in terms of liquidity.
    • Despite having a current ratio of about 1.0, the quick ratio is slightly below 1.0.
    • This means that the company may face liquidity problems should payment of current liabilities be demanded immediately.
    • Debt Ratio = Total Debt / Total Assets = 6,500/13,840 = 47 percent

  • Measuring the Money Supply

    • Base money can be described as the most acceptable (or liquid) form of final payment.
    • This is the base from which other forms of money (like checking deposits) are created and is traditionally the most liquid measure of the money supply.
    • The ratio of a pair of these measures, most often M2/M0, is called an (actual, empirical) money multiplier.
    • Liquid assets include coins, paper currency, checkable-type deposits, and traveler's checks.
    • Less liquid assets include money market deposits and savings account deposits.

  • Performance per Share

    • Valuation ratios describe the value of shares to shareholders, and include the EPS ratio, the P/E ratio, and the dividend yield ratio.
    • Price to Earnings (P/E) ratio relates market price to earnings per share.
    • A higher P/E ratio means that investors are paying more for each unit of net income; therefore, the stock is more expensive compared to one with a lower P/E ratio.
    • P/E Ratio = Market Price Per Share / Annual Earnings Per Share .
    • Dividend payout ratio is the fraction of net income a firm pays to its stockholders in dividends: Dividend Payout Ratio = Dividends / Net Income for the Same Period.

  • Debt Utilization Ratios

    • In this case, it has a debt ratio of 200%.
    • The debt ratio is a financial ratio that indicates the percentage of a company's assets that are provided via debt.
    • Like all financial ratios, a company's debt ratio should be compared with their industry average or other competing firms.
    • The debt service coverage ratio (DSCR), also known as debt coverage ratio (DCR), is the ratio of cash available for debt servicing to interest, principal, and lease payments.
    • A similar debt utilization ratio is the times interest earned (TIE), or interest coverage ratio.

  • The Imperative of Liquidity

    • Organizations must carefully manage their cash flow statements to ensure appropriate liquidity to avoid missing investment opportunities.
    • To accurately frame the discussion of cash flows, an understanding of liquidity is integral.
    • Company C will capture the opportunity, as the capital they are using is more liquid.
    • When considering cash flow, it is important to understand liquidity risk.
    • Business managers and accountants, when considering their investment options, should keep liquidity in mind at all times.

  • Activity Ratios

    • Activity ratios provide useful insights regarding an organization's ability to leverage existing assets efficiently.
    • Activity ratios are essentially indicators of how a given organization leverages their existing assets to generate value.
    • Understanding how to use these ratios, and what the implications are, is central to financial and managerial accounting at the strategic level.

  • Profitability Ratios

    • Profitability ratios are used to assess a business's ability to generate earnings.
    • Other profitability ratios include:
    • Profit Margin: The profit margin is one of the most used profitability ratios.
    • The profit margin ratio is broadly the ratio of profit to total sales times one hundred percent.
    • Basic Earning Power Ratio: The basic earning power ratio (or BEP ratio) compares earnings separately from the influence of taxes or financial leverage to the assets of the company.

  • Comparisons Within an Industry

    • Ratios of risk such as the current ratio, the interest coverage, and the equity percentage have no theoretical benchmarks.
    • Similarly, if the equity ratio increases over time, it is a good sign in relation to insolvency risk.
    • Ratios must be compared with other firms in the same industry to see if they are in line .
    • Ratio analyses can be used to compare between companies within the same industry.
    • For example, comparing the ratios of BP and Exxon Mobil would be appropriate, whereas comparing the ratios of BP and General Mills would be inappropriate.

  • The Reserve Requirement

    • Suppose that the Fed sets the reserve ratio at 10% for net transaction accounts between $6 million and $15 million.
    • The Federal Reserve can adjust reserve requirements by changing required reserve ratios, the liabilities to which the ratios apply, or both.
    • Unless it is accompanied by an increase in the supply of Federal Reserve balances, an increase in reserve requirements (through an increase in the required reserve ratio, for example) reduces excess reserves, induces a contraction in bank credit and deposit levels, and raises interest rates.