# Accounting Ratios Notes1

## COMPANY - ACCOUNTING RATIOS

#### I.  LIQUIDITY RATIOS

##### A.  Meaning
• The term liquidity refers to the ability of the company to meet its current liabilities.
• Liquidity ratios are financial ratios that help in analyzing the ability of a business entity to meet its short-term obligations/liabilities.
• Liquidity ratios measure the firms’ ability to fulfil short term commitments out of its liquid assets
• These are analysed by looking at the amounts of current assets and current liabilities in the balance sheet.
• Higher ratio means better capacity to meet its current obligation.
##### C. Current Ratio
###### a. Meaning
• The Current ratio measures the ability of a company to pay its current liabilities using its current assets.
• A higher Current ratio indicates that the company has sufficient current assets to meet its current liabilities.
###### b. Formula
• It is calculated by dividing Current Assets by Current Liabilities.
• Current Ratio = Current AssetsCurrent Liabilities
• Current Assets = Current Investments + Inventories (excluding stores & spares and Loose tools) + Trade Receivables (Net of provisions) + Cash & Cash equivalents + Short Term Loans & Advances + Other Current Assets
• Current Liabilities = Short Term Borrowings + Trade Payables + Other Current Liabilities + Short Term Provisions
• Working Capital = Current Assets – Current Liabilities
###### c. Important Considerations
• The ratio is expressed pure i.e. 2:1
• The ideal range for the Current ratio is 2:1
• A Current ratio of less than 1 indicates that the company may have difficulty meeting its current liabilities.
• Higher Current ratio means better capacity to meet its current obligations.
• Very high Current ratio shows funds idleness
##### D. Liquid Ratio
###### a. Meaning
• The Liquid ratio is a more stringent measure of liquidity. It measures the ability of a company to meet its current liabilities using its quick assets, which include cash, marketable securities, and accounts receivable.
• Its based on highly liquid assets that can be converted into cash quickly
• The Liquid ratio is also known as Quick ratio or Acid-test ratio.
###### b. Formula
• It is calculated by dividing Liquid Assets by Current Liabilities.
• Liquid Ratio = Liquid Assets/Current Liabilities
• Liquid Assets = Current Investments + Trade Receivables (Net of provisions) + Cash & Cash equivalents + Short Term Loans & Advances + Other Current Assets excluding Prepaid Expenses
• Current Liabilities = Short Term Borrowings + Trade Payables + Other Current Liabilities + Short Term Provisions
• Liquid Assets = Current Assets – Inventories – Prepaid Expenses
###### c. Important Considerations
• The ratio is expressed pure i.e. 2:1
• The ideal range for the Liquid ratio is 1.5 : 1
• A  Liquid ratio  less than 1 indicates that the company may have difficulty meeting its current liabilities even if all of its current assets are liquidated.
• Higher Liquid ratio means better capacity to meet its current obligations.
• Very high Liquid ratio shows funds idleness
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