Learning Value Investing: Liquidity Measurement Ratios for Analyzing a Stock ( Current Ratio )

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Series: Ratio Analysis (2 post )

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Liquidity Measurement Ratios.

The concept behind this ratio is to ascertain whether a company's short-term assets (cash, cash equivalents, marketable securities, receivables and inventory) are readily available to pay off its short-term liabilities. In theory, the higher the current ratio, the better.

The ratios that we'll look at are the current, quick and cash ratios and we will also go over the cash conversion cycle, which goes into how the company turns its inventory into cash.

Current Ratio:

Current ratio expresses the extent to which the current liabilities of a business (i.e. liabilities due to be settled within 12 months) are covered by its current assets (i.e. assets expected to be realized within 12 months). A current ratio of 2 would mean that current assets are sufficient to cover for twice the amount of a company's short term liabilities. –

Generally, companies would aim to maintain a current ratio of at least 1 to ensure that the value of their current assets cover at least the amount of their short term obligations. However, a current ratio of greater than 1 provides additional cushion against unforeseeable contingencies that may arise in the short term. –

Current ratio must be analyzed over a period of time. Increase in current ratio over a period of time may suggest improved liquidity of the company or a more conservative approach to working capital management. A decreasing trend in the current ratio may suggest a deteriorating liquidity position of the business or a leaner working capital cycle of the company through the adoption of more efficient management practices. Time period analyses of the current ratio must also consider seasonal fluctuations.

Current ratio must be analyzed in the context of the norms of a particular industry. What may be considered normal in one industry may not be considered likewise in another sector.

Formula : Current Assets / Current Liabilities

Example:

Go to Moneycontrol.com Website here is an Online Link for the same

http://www.moneycontrol.com/financials/relianceindustries/ratios/RI#RI

select the Ratios under the Financials Tab & look for the Liquidity And Solvency Ratios

Next Post on Beginning Investing: Liquidity Measurement Ratios (QuickRatio)

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