Reading Financial Reports for Liquidity Ratios
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.
Current ratio gives you a good idea of whether a company will be able to pay any bills due over the next 12 months with assets it has on hand.
Current ratio = Current assets divided by 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 divided by Current liabilities
Interest coverage ratio lets you know whether a company is bringing in enough money to pay interest on whatever outstanding debt it has.
Interest coverage ratio = EBITDA divided by Interest expense