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# Liquidity ratio Liquidity represents ones ability to pay its current obligations or short -term debts within a period

less than one year. Liquidity ratios, therefore, measures a companys liquidity position. The ratios are important from the viewpoint of its creditors as well as management. Above are definition taken from www.readyrations.com where in a simple words liquidity ratios are one of the ways to determine the ability of the company in paying off their shortterm debts within a year. Liquidity ratio is a calculation of a companys available cash and marketable securities against outstanding debt. The ratio measures the companys ability to pay its short-term debts. A high ratio indicates a company with a low risk of default. In order to measure the effectiveness of the company, there are four elements that used in computation to indicate the level of companys effectiveness. Elements of liquidity ratio are as follows: a) Current ratio b) Quick ratio or acid test ratio c) Cash ratio d) Net working capital Current ratio The ratio is mainly used to give an idea of the company's ability to pay back its short-term liabilities (debt and payables) with its short-term assets (cash, inventory, receivables). The higher the current ratio, the more capable the company is of paying its obligations. A ratio under 1 suggests that the company would be unable to pay off its obligations if they came due at that point. While this shows the company is not in good financial health, it does not necessarily mean that it will go bankrupt - as there are many ways to access financing - but it is definitely not a good sign. The current ratio can give a sense of the efficiency of a company's operating cycle or its ability to turn its product into cash. Companies that have trouble getting paid on their receivables or have long inventory turnover can run into liquidity problems because they are unable to alleviate their obligations. Because business operations differ in each industry, it is always more useful to compare companies within the same industry

(http://www.investopedia.com).

Calculation (formula) The current ratio is calculated by dividing current assets by current liabilities: The current ratio = Current Assets Current Liabilities

Both variables are shown on the balance sheet (statement of financial position).

Ratio

Current ratio:

## Current assets Current liability

51,816 57,142

38,129 31,946

= 0.907 Times

= 1.194 Times

Result from the analysis By referring to the above analysis, in 2011 Stone Master company has low efficiency in paying off their obligation where the company gain 0.9 times which indicated that the company has unhealthy financial position. However in 2012, the financial has been improved by 1.2 times which indicated that the company efficiently manage the obligations. Quick ratio or Acid test ratio The quick ratio is more conservative than the current ratio, a more well-known liquidity measure, because it excludes inventory from current assets. Inventory is excluded because some companies have difficulty turning their inventory into cash. In the event that short-term obligations need to be paid off immediately, there are situations in which the current ratio would overestimate a company's short-term financial strength. Acid test Ratio therefore is an indicator of a company's short-term liquidity. The quick ratio measures a company's

ability to meet its short-term obligations with its most liquid assets. The higher the quick ratio, the better the position of the company (http://www.investopedia.com). The formula for the acid-test ratio is: Quick ratio = (Current Assets Inventory) Current liabilities

Ratio

## Year ended 30/09/2012 (RM000)

Quick ratio or Acid test ratio: Current Assets Inventory Current Liability 51,816 18,874 57,142 38,129 10,002 31,946

= 0.576 Times

= 0.880 Times

Result from the analysis As mentioned in the above definition, acid test ratio is used by the company in order to measure the ability of paying off its debts by excluding inventory. Inventories are the main resources of assets. From the analysis above it show that in 2011 the quick ratio is 0.56 times as compared in 2012 the quick ratio is increased to 0.88 times. During 2011 Stone Master unable to meet their debts well as compared in 2012. Cash Ratio Cash ratio is a refinement of quick ratio and indicates the extent to which readily available funds can pay off current liabilities. Potential creditors use this ratio as a measure of a company's liquidity and how easily it can service debt and cover short-term liabilities (www.readyrations.com). Cash ratio is the most stringent and conservative of the three liquidity ratios (current, quick and cash ratio). It only looks at the company's most liquid short-term assets cash and cash

equivalents which can be most easily used to pay off current obligations (www.readyrations.com). Calculation (formula) Cash ratio is calculated by dividing absolute liquid assets by current liabilities: Cash ratio = Cash Current Liabilities Both variables are shown on the balance sheet (statement of financial position).

Ratio

Cash Ratio:

## Cash Current liabilities

471 57,142

151 31,946

= 0.008 Times

= 0.005 Times

Result from the analysis During 2011 Stone Master able to meet their obligations where the cash ratio is 0.008 times. However in 2012 the ability decreased to 0.005 times which indicated that Stone Master faced problems in paying off their current debts in cash. Reduction in cash is the problem of the failure of Stone Master in paying off their current debts. This shows that the company have not make much profit as compared in 2011. Net Working Capital (NWC) Working capital is the amount by which the value of a company's current assets exceeds its current liabilities. Also called net working capital. Sometimes the term "working capital" is used as synonym for "current assets" but more frequently as "net working capital", i.e. the amount of current assets that is in excess of current liabilities. Working capital is frequently

used to measure a firm's ability to meet current obligations. It measures how much in liquid assets a company has available to build its business. Working capital is a common measure of a company's liquidity, efficiency, and overall health. Decisions relating to working capital and short term financing are referred to as working capital management. These involve managing the relationship between an entity's short-term assets (inventories, accounts receivable, cash) and its short-term liabilities. Calculation (formula) Working capital (net working capital) = Current Assets - Current Liabilities Both variables are shown on the balance sheet (statement of financial position).

Ratio

## 38,129 31,946 = 6,183

Result from the analysis During 2011 Stone Masters net working capital is at negative amount which is RM 5,326. This means that during 2011 Stone Master Corporation unable to paying all their creditors. This scenario might worst if Stone Master fail to overcome it which cause bankrupt. However Stone Master manages to overcome the problem where the net working capital shows the increment of RM 6,183 in 2012. Conclusion From the analysis, it can be conclude that in 2012 Stone Master Corporation manages to overcome all their obligations. Therefore for the overall, it shows that Stone Master Corporation has good financial position and efficient in managing their obligation although in

2011 the company has problems in managing their debts. It is a good improvement done by Stone Master in overcomes their problems.