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Liquidity Ratios
Short term liquidity - The primary concern of short-term
creditors when assessing the strength of a firm
Liquidity - Short-term creditors are usually most interested
in assessing this
Liquidity and activity ratios - The two categories of ratios
that should be utilized to asses a firms true liquidity
Liquidity - most of interest to a firms suppliers
The ratios that are used to determine a companys short-term
debt paying ability are current ratio, acid-test ratio,
receivables turnover, and inventory turnover.
Current ratio - is a measure of the liquidity position of a
corporation
Current ratio - ratios would not likely be used by a shortterm creditor in evaluating whether to sell on credit to a
company
Current ratio - ratios would be least helpful in appraising
the liquidity of current assets
Accounts receivable turnover - ratio is most helpful in
appraising the liquidity of current assets
Current ratio - considered to be the most indicative of a
firm's short-term debt paying ability
Current ratio - is rated to be a primary measure of liquidity
and considered of highest significance rating of the liquidity
ratios a bank analyst
A weakness of the current ratio is that it does not take into
account the composition of the current assets.
Acid-test ratio - A measure of a companys immediate shortterm liquidity
The acid-test or quick ratio relates cash, short-term
investments, and net receivables to current liabilities.
Activity Ratios
A general rule to use in assessing the average collection
period is that it should not greatly exceed the credit term
period.
Asset turnover measures how efficiently a company uses its
assets to generate sales.
Total asset turnover measures the ability of a firm to
generate sales through the use of assets
A measure of how efficiently a company uses its assets to
generate sales is the asset turnover ratio.
Long-term creditors are usually most interested in evaluating
solvency.
Trading on the equity (leverage) refers to the use of borrowed
money to increase the return to owners.
The tendency of the rate earned on stockholders' equity to
vary disproportionately from the rate earned on total assets
is sometimes referred to as leverage.
be abnormally high.
A firm with a total asset turnover lower than the industry
standard and a current ratio which meets industry standard
might have excessive fixed assets.
A firm has a current ratio of 1:1.
In order to improve its
liquidity
ratios,
this
firm
should
decrease
current
liabilities
by
utilizing
more
long-term
debt,
thereby
increasing the current and quick ratios.
Tyner Company had P250,000 of current assets and P90,000 of
current liabilities before borrowing P60,000 from the bank
with a 3-month note payable. What effect did the borrowing
transaction have on Tyner Company's current ratio? The ratio
decreased.
Jones Company has long-term debt of P1,000,000, while Smith
Company, Jones' competitor, has long-term debt of P200,000.
Which of the following statements best represents an analysis
of the long-term debt position of these two firms? Not enough
information to determine if any of the answers are correct.
A rise in preferred stock dividends will not cause times
interest earned to drop? Assume no other changes than those
listed.