LIQUIDITY

RATIOS
Group 1 presentation
AGENDA
1. What is Liqudity Ratio?
2. What are its types?
3. How to solve them?
4. How to analyze them?
 What are
Liquidity Ratios?
Objective 1
Liquidity Ratios
Liquidity is the ability to convert assets into cash
quickly and cheaply.
It is the capacity of a company to pay its currently
maturing obligation - current liabilities.
Liquidity Ratios
The liquidity ratio will determine if a company could
pay the borrowed principal amount and interest
when they fall due.
The liquidity ratio is important to short term
creditors (suppliers).
What are its
types?
Objective 2
 Types of
Liquidity Ratios
Working capital
 Working Capital
Simplest liquidity ratio.
It is the money available to meet your current or short-
term obligations.
The money available to run the operations of the company.
Higher working capital means that there are enough
current assets to pay all the current liabilities.
Formula: current assets - current liabilities = working
capital
 Types of
Liquidity Ratios
Current Ratio
 Current Ratio
It is the ratio that measures whether the firm has enough
resources to meet its short-term obligations.
A good current ratio is between 1.2 to 2, which means that
the business has 2 times more current assets than current
liabilities to cover its debts.
A current ratio below 1 means that the company doesn’t have
enough liquid assets to cover its short-term liabilities.
Formula: current assets /current liabilities = current
ratio
 Types of
Liquidity Ratios
Acid Test Ratio or Quick Ratio
 Acid Test Ratio or
Quick Ratio
A more strict version of the current ratio formula.
Quick assets are only included because quick assets are more
liquid. Quick assets are cash, accounts receivable, and trading
securities.
Higher quick ratio means that a company has the capability
to pay its maturing obligations just through its quick assets.
Formula: quick assets/current liabilities = acid test ratio or
quick ratio
 Types of
Liquidity Ratios
Accounts Receivable Turnover Ratio
 Accounts Receivable
Turnover Ratio
This ratio measures how frequent the company was able to
convert their accounts receivable into cash.
Higher accounts receivable turnover ratio means that the
company was more persistent in collecting their accounts
receivables.
A company uses their total Net Credit Sales but this data is
not usually present. As an alternative, a company could make
use of Total Net Sales.
 Accounts Receivable
Turnover Ratio
Average accounts receivable can be computed by adding
the beginning and ending balances of the accounts
receivable and dividing it by 2.
Formula: net sales/average accounts receivable =
accounts receivable turnover ratio
 Types of
Liquidity Ratios
Average Collection Period
 Average Collection
Period
The average collection period pertains to the number of
days it takes for a company to collect their accounts
receivable.
A shorter average collection period is generally preferable
and means a business has higher liquidity.
Formula: number of days in a year (360 or 365 or 366)/accounts

receivable turnover ratio = average collection period

 Types of
Liquidity Ratios
Inventory Turnover Ratio
 Inventory Turnover
Ratio
This ratio measures the number of times the company was
able to sell its entire inventory during the period.
Higher inventory turnover ratio means that the company is
more effective in selling their inventory to their
customers.
Formula: cost of goods sold/average inventory = inventory
turnover ratio
 Types of
Liquidity Ratios
Average Days in Inventory
Average Days in Inventory
The average days in inventory pertains to the number of
days it takes to sell the entire inventory.
Shorter average inventory days means that the cash of
the company is not tied to its inventory for a very long
period of time.
Formula: number of days in a year (360 or 365 or

366)/inventory turnover ratio = average days in inventory

 Types of
Liquidity Ratios
Number of Days in Operating Cycle
 Number of Days in
Operating Cycle
This is the measure on how long it will take for the
company to transform its inventory back to cash.
Shorter number of days indicates that the company will
have additional cash at an earlier time.
Formula: average collection period + average days in
inventory = number of days in the operating cycle.
Summary for a Positive
Liquidity Ratio of a
Company
 Ratio Value / Number of Days

Type of Liquidity Ratio

High Value / Longer Period

Low Value / Shorter Period

1. Working Capital

2. Current Ratio

3. Quick Ratio

4. Accounts Receivable

Turnover Ratio ✔

5. Average Collection
Period

6. Inventory Turnover
Ratio

7. Average Days
Inventory

in

8. Number of Days

Operating Cycle
in

 ACTIVITY
ACTIVITY
Guidelines (Boardwork Activity):
1. The class will be divided into two groups.
2. Each group shall select 2 representatives to answer or solve each
item. Repetition of representatives is not allowed.
3. The representative is allowed to bring their calculator.
4. The first representative who correctly answered the problem shall
receive the point.
5. The group that earned the greatest number of points will be the
winner.
Working Capital
 Working Capital
2015 2016
Current Assets 520,000 620,000
Less: Current Liabilities (70,000) (50,000)
Working Capital P450,000.00 P570,000.00
 Working Capital
In 2016, JKL Company’s working capital had increased by
Php 120,000. Despite the company having positive working capital
in 2015 and 2016, comparing these two periods together, it can
be seen that the company’s performance in 2016 was a step
ahead of 2015. This reveals that JKL Company had sufficient cash
allocated to financing its day-to-day operation for both years,
but preferably, in 2016.
Current Ratio
 Current Ratio
2015 2016
Total Current Assets 520,000 620,000
÷ ÷
Total Current Liabilities 70,000 50,000
Current Ratio 7.43 12.4
 Current Ratio

In 2015, JKL Company had a 7.4 current ratio which

increased to 12.4 in 2016. Comparing the two periods
together, the company has a better current ratio in
2016 than in 2015.
Quick Ratio
 Quick Ratio
2015 2016
QUICK Assets 450,000 520,000
÷ ÷
Total Current Liabilities 70,000 50,000
QUICK Ratio 6.43 times 12.4 times
 Quick Ratio
For 2015 and 2016, the company obtained a positive acid
test ratio. This indicates that the company has the ability
to use its liquid assets to settle its existing maturing
obligations. The acid test ratio was 6.43 in 2015 and 10.4
in 2016. Since the 2016 acid test ratio was higher than the
2015 acid test ratio, the company performed better in
2016 than it did in 2015.
Accounts Receivable Turnover
Ratio

Accounts Receivable Turnover

Ratio

2015 2016
Net Sales Php 900,000 Php 700,000
÷ Average Accounts Receivable ÷120,000 ÷ 110,000
A/R Turnover ratio 7.5 times 6.36 times
Accounts Receivable Turnover
Ratio
In the data given, comparing the two periods shows that
the year 2015 is higher than 2016. The A/R Turnover ratio
in 2015 is 7.5 times while 6.36 in 2016. We can conclude
that JKL Company's performance is not good from its
collection department.
Average Collection Period

Average Collection Period

2015 2016
Days 365 366
÷A/R Turnover Ratio ÷7.5 ÷6.36
Average Collection Period 48.66 days 57.54 days
Average Collection Period
The data shows that the collection department has decreased its effort to
collect the company's receivables as they fall due since the average collection
period for 2016 is longer.

The conclusion for A/R Turnover Ratio would be the same for the average
collection period.The reason is that A/R Turnover Ratio is a component of the
formula for the average collection period.It can be seen in the computation
that the company has better A/R Turnover Ratio and Average Collection Period
in 2015 than 2016.
Inventory Turnover Ratio
Inventory Turnover Ratio

2015 2016
COGS 80,000 100,000
÷Average Inventory ÷60,000 ÷70,000
Inventory Turnover Ratio 1.33 times 1.43 times
Inventory Turnover Ratio

The inventory turnover ratio increased in 2016 so we can

conclude that the sales department sold more products
to customers in 2016.
Average days in inventory
Average days in inventory

2015 2016
Number of Days in a Year 365 366
Inventory Turnover Ratio ÷ 1.33 ÷ 1.43
Average Days in Inventory 274.43 days 255.94 days
Average days in inventory

Days in inventory is the average time a company keeps its

inventory before it's sold. The data above shows the
average days in inventory of JKL. This means that the
company improved in selling their inventory, since the
inventory is not in the hands of the company for a longer
time.
Number of Days in the
Operating Cycle
Number of Days in the
Operating Cycle
2015 2016
Collection Period 48.66 57.44
÷ Average Age of Inventory + 274.43 + 255.94 .
No. of Days in the Operating Cycle 323.09 days 313.8 days
 Number of Days in the
Operating Cycle
In the data given, the comparison between 2015 and 2016
shows that there was an improvement of at least 9 days in the
company’s operating cycle. JKL Company in 2016 improved as a
whole when it comes to liquifying their products into cash or
receivables.