Interpretations of short term solvency or liquidity ratio''s, Financial Management

Short Term Solvency or Liquidity Ratio's

 

CR:          The Current Ratio is calculated by current assets to current liabilities and is the index of company's financial stability. The most expected ratio is 2:1 although the standard ratio 2:1 may differ from industry to industry and therefore the standard of liquidity of any particular business or industry depends upon the nature of that business or industry. This ratio reveals the company's ability to meet its current liabilities. For solvency tests this ratio serves a very useful purpose and represents a margin of safety for short-term creditors. Higher the ratio, the greater is the margin of safety but lesser is the management efficiency with reference to idle funds, poor credit collection policy and an imparity between inventories holding and current requirements and thus a case of under trading. On the other hand lower ratio is the indicator of less margin of safety and a case of overtrading.

 

QR:          Quick ratio or Acid Test ratio is the ratio of quick current assets (current assets - inventories) to quick current liabilities (including bank overdraft) and is a subsidiary to current ratio because it also reveals the company's ability to meet its immediate liabilities. For this ratio, Bankers thumb rule is 1:1 i.e. for every Re. 1 of quick current liabilities there must be Re. 1 quick current assets, and is considered satisfactory. For solvency test, acid test ratio serves a more rigorous measure of liquidity and is considered a better test of financial strength than the current ratio.

 

 

 

 

 

Posted Date: 7/26/2012 3:59:44 AM | Location : United States







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