Liquidity Ratios

Current Ratio

Current Ratio = current assets/current liabilities The current ratio is the best-known measure of liquidity.

Defensive Interval

Defensive Interval = (cash + marketable securities + receivables)/average daily expenditures The defensive interval ratio is another measure of liquidity that indicates the number of days of average cash expenditures the firm could pay with its current liquid assets. Expenditures here include cash expenses for cost of goods, SG&A, and research and development. If these items are taken from the income statement, noncash charges such as depreciation should be added back just as in the preparation of a statement of cash flows by the indirect method.

Cash Conversion Cycle

Cash Conversion Cycle = (days sales outstanding) + (days of inventory on hand) + (number of days of payables) The cash conversion cycle is the length of time it takes to turn the firm's cash investment in inventory back into cash, in the firm of collections from the sales of that inventory. High cash conversion cycles are undesirable. A conversion cycle that is too high implies that the company has an excessive amount of capital investment in the sales process.

Cash Ratio

Cash Ratio = (cash + marketable securities)/current liabilities The most conservative liquidity measure is the cash ratio.

Liquidity Ratios

Liquidity here refers to the ability to pay short-term obligations as they come due. Liquidity ratios are employed by analyst to determine the firm's ability to pay its short-term liabilities.

Quick Ratio

Quick Ratio = (cash + marketable securities + receivables)/current liabilities The quick ratio is a more stringent measure of liquidity because it does not include inventories and other assets that might not be very liquid