Questions and Answers
What is the formula for calculating the Quick Ratio?
(Cash + Accounts Receivable + Marketable Securities) / Current Liabilities
How is the Working Capital Ratio calculated?
Current Assets / Total Current Liabilities
What does a Working Capital Ratio greater than 1 imply?
It implies that the company has sufficient resources to cover shortterm obligations.
What does the Operating Cash Flow Ratio assess?
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What does an Operating Cash Flow Ratio of 1 or higher suggest?
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How do liquidity ratios contribute to analyzing a company's financial strength?
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What is the formula for calculating the current ratio?
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What does a current ratio greater than 1 indicate?
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What is the cash ratio, and how is it calculated?
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What does a high cash ratio indicate about a company's financial position?
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What assets are included in the quick ratio calculation?
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What are the five key liquidity ratios discussed in the text?
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Study Notes
Financial Ratio Liquidity: Understanding Current Ratio, Cash Ratio, Quick Ratio, Working Capital Ratio, and Operating Cash Flow Ratio
Financial liquidity ratios are crucial indicators of a company's ability to meet its shortterm financial obligations. These ratios help investors and analysts evaluate a company's financial health and assess its capacity to generate cash flows. Here, we'll discuss five key liquidity ratios:

Current Ratio: This is the simplest liquidity ratio, computed by dividing a company's current assets by its current liabilities. It provides an overall assessment of a company's ability to pay off its shortterm debts using its current assets. A current ratio greater than 1 suggests sufficient liquidity, indicating that the company has enough assets to cover all its shortterm liabilities.
Current Ratio = Current Assets / Current Liabilities

Cash Ratio: Also known as the cashtodebt ratio, the cash ratio is a strict test of a company's liquidity. It divides net cash (cash plus marketable securities) by total liabilities. A high cash ratio indicates that a company has minimal shortterm debt, relying mostly on cash to settle its current liabilities.
Cash Ratio = (Cash + Marketable Securities) / Total Liabilities

Quick Ratio: Similar to the current ratio, the quick ratio focuses solely on the most liquid assets, including cash, marketable securities, and accounts receivable. By leaving out less liquid assets such as inventory and prepaid expenses, it provides a truer representation of a company's ability to meet immediate obligations.
Quick Ratio = (Cash + Accounts Receivable + Marketable Securities) / Current Liabilities

Working Capital Ratio: This ratio shows the relationship between a company's current assets and its total current liabilities. It is calculated by dividing a company's current assets by its total current liabilities. A working capital ratio greater than 1 implies that a company has sufficient resources to cover its shortterm obligations.
Working Capital Ratio = Current Assets / Total Current Liabilities

Operating Cash Flow Ratio: Unlike the previously mentioned ratios, which focus on the liquidity aspects of a company, the operating cash flow ratio assesses a firm's ability to generate cash through its core business activities. It is determined by dividing operating cash flow by current liabilities. A ratio of 1 or higher suggests that a company can cover its shortterm obligations with its operating cash flow alone.
Operating Cash Flow Ratio = Operating Cash Flow / Current Liabilities
These five liquidity ratios play a significant role in demonstrating a company's ability to handle its shortterm financial responsibilities. They allow investors and analysts to analyze a company's financial strength, identify any potential risks related to its liquidity, and compare its performance against industry peers.
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Description
Test your knowledge on key financial liquidity ratios like current ratio, cash ratio, quick ratio, working capital ratio, and operating cash flow ratio. Learn how these ratios help assess a company's liquidity, financial health, and ability to meet shortterm obligations.