Liquidity

• Liquidity ratio


  Measure of a business's ability to pay amounts owed when they are due
• Current assets


  Assets that can be easily converted to cash, including cash, inventory, and accounts receivable
• Current liabilities


  Obligations that must be paid within one year, including accounts payable and short-term debt
• Calculating the current ratio

  1. Add up current assets

  2. Add up current liabilities

  3. Divide current assets by current liabilities
• Current ratio


  • Typical range is 1.5 to 2.5
  • Indicates whether business has enough current assets to cover current liabilities
• Acid test ratio


  Current ratio with inventory removed from current assets
• Acid test ratio is a more stringent test of liquidity than the current ratio
• High inventory levels


  Reduce the acid test ratio compared to the current ratio
• Businesses with high inventory turnover can operate with a low current ratio and acid test ratio
• Analyzing liquidity ratios requires understanding the specific industry and business context
• The current ratio measures the ability to pay short-term obligations with current assets.
• Cash flow forecasting involves estimating future cash inflows and outflows based on historical data and assumptions about future events.
• Inventory management strategies such as just-in-time (JIT) systems can reduce inventory levels without affecting sales.
• A positive net present value (NPV) indicates that an investment will generate enough cash flows to cover its initial cost, while a negative NPV suggests that it may not be profitable.
• Payback period refers to the time required for an investment to recoup its original costs through cash flows generated by the project.
• A higher current ratio indicates better liquidity, but it may not be necessary if the company has good credit terms or sells on credit.
• Payback period refers to the time required for an investment to recoup its original costs through cash flows generated from the project.
• Net present value (NPV) is calculated by subtracting the total present value of all expected cash outflows from the total present value of all expected cash inflows.
• The liquidity ratios measure the ability to meet short-term obligations with available resources.
• Project A has a shorter payback period than Project B, making it more attractive even though both have the same NPV.