How Liquidity Ratios Figure into Company Reports
If a company doesn’t have cash on hand to cover its day-to-day operations, it’s probably on shaky ground. Use the following formulas to find out whether a company has plenty of liquid (easily converted to cash) assets when you’re reading the company report.
Current ratio gives you a good idea whether a company will be able to pay any bills due over the next twelve months with assets it has on hand.
Current ratio = Current assets ÷ Current liabilities
Quick ratio or acid test ratio shows a company’s ability to pay its bills using only cash on hand or cash already due from accounts receivable. It doesn’t include money anticipated from the sale of inventory and the collection of the money from those sales.
Quick ratio = Quick assets ÷ Current liabilities
Income gearing lets you know whether a company is bringing in enough money to pay the interest on whatever outstanding debt it has.
Income gearing = Interest paid divided by operating profit
Cash flow coverage ratio finds out whether a company has enough money to cover its bills and finance growth.
Cash flow coverage ratio = Cash flows from operating activities ÷ cash requirements