RATIO ANALYSIS
Financial statements report both on a firm’s position at a point in time and on its operations over some past period. However, the real value of financial statements lies in the fact that they can be used to help predict future earnings and dividends.
From an investor’s standpoint, predicting the future is what financial statement analysis is all about, while from management’s standpoint, financial statement analysis is useful both to help anticipate future conditions and, more important,as a starting point for planning actions that will improve the firm’s future performance.
Liquidity Ratios
Liquid Asset
An asset that can be converted to cash quickly.
Liquidity Ratios
Ratios that show the relationship of a firm’s cash and other current assets to its current liabilities.
Current Ratio
Current ratio =Current assets/Current liabilities
Current ratio =xxx times
It indicates the extent to which current liabilities are covered by those assets expected to be converted to cash in the near future.
Current assets normally include cash, marketable securities, accounts receivable,and inventories. Current liabilities consist of accounts payable, short-term notes payable, current maturities of long-term debt, accrued taxes, and other accrued expenses (principally wages).
Quick (Acid Test) Ratio
Quick, or acid test, ratio =(Current assets - Inventories)/Current liabilities
Quick, or acid test, ratio =xxx times
Inventories are typically the least liquid of a firm’s current assets, hence they are the assets on which losses are most likely to occur in the event of liquidation.Therefore, a measure of the firm’s ability to pay off short-term obligations without relying on the sale of inventories is important.
Reference:Fundamentals of Financial Management, Concise - Brigham-Houston
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