Liquidity indicators (Liquidity Ratios)
Liquidity indicators (Liquidity Ratios)
Liquidity is the ability of assets to be quickly sold at a price close to the market price. Liquidity is also the ability to appeal to money (see the term "liquid assets").
Usually distinguish highly liquid, low liquid and illiquid values (assets). The easier and faster it is to get the asset for its full value, the more liquid it is. For the product "liquidity" will correspond to the speed of its sale at a nominal price.
In practice, it is accepted to allocate 4 groups of liquidity of assets:
A1 — the most liquid assets;
A2 — quickly sold assets;
A3 — slowly sold assets;
A4 — hard-to-sell assets.
The division is performed to determine the liquidity of the enterprise or the liquidity of the balance sheet. To this end, funding sources are divided into 4 groups:
L1 — the most urgent obligations;
L2 — short-term liabilities;
L3 — long-term liabilities;
L4 — constant liabilities.
Based on these groups, liquidity ratios are calculated.
To determine the liquidity of the balance sheet, you must compare the results for each group of assets and liabilities. Ideal is the liquidity, under which the following conditions are met:
A1 > L1;
A2 > L2;
A3 > L3;
A4 < L4.
In the practice of financial analysis there are three main indicators of liquidity:
absolute liquidity,
urgent a liquidity and
current (total) liquidity.
- Coefficient of absolute liquidity (Cash ratio)
Absolute liquidity ratio is a financial ratio equal to the ratio of cash and short-term financial investments to short-term liabilities (current liabilities).
Absolute liquidity ratio = (Cash assets + Short-term financial investments) / Current liabilities
It is considered that the normal value of the coefficient must be not less than 0.2, that is, every day can potentially be paid 20% of term commitments. It shows what part of short-term debt the company can pay off in the near future.
- Coefficient of urgent liquidity (Quick ratio, QR)
Urgent liquidity ratio (sometimes referred to as intermediate or quick liquidity) is a financial ratio equal to the ratio of highly liquid current assets to short-term liabilities (current liabilities):
Urgent liquidity ratio = (Cash assets + Short-term financial investments + Short-term accounts receivable) / Short-term liabilities
The ratio reflects the ability of the company to pay off its current liabilities in the event of difficulties with the sale of products.
The normal value of the coefficient is not less than 1.
- Coefficient of current (general) liquidity (Current ratio, CR)
The ratio of current (total) liquidity (coverage ratio) is a financial ratio equal to the ratio of current (current) assets to short-term liabilities (current liabilities).
Current Ratio = Current Assets / Current Liabilities
The ratio reflects the ability of the company to repay current (short-term) liabilities at the expense of only current assets. The higher the indicator, the better the solvency of the enterprise.
The normal value of the coefficient 2 or more (this value most often used in Russian regulatory acts; in the world practice is normal from 1.5 to 2.5, depending on the industry). A value below 1 indicates a high financial risk associated with the fact that the company is unable to consistently pay the current bills. A value greater than 3 can testify to an irrational capital structure.
- Net Working Capital (NWC)
Net working capital is one of the most important indicators that is used in the financial analysis of the company. The indicator characterizes the amount of working capital free of short-term liabilities. The second name of the coefficient is "working capital". Net Working Capital (NWC) - the difference between the value of current assets and current liabilities.
Working capital = Current assets - Current liabilities
The net working capital necessary to maintain the financial stability of the company. The excess of current assets over short-term liabilities means that the company can repay its short-term liabilities and reserves for expansion.
The recommended value of NWC is more than 0.