Liquidity Ratios and Activity Ratios
2.0 FINANCIAL RATIOS
2 Liquidity Ratios
Liquidity ratios measure a business ' capacity to pay its debts as they come due. It also measures the cooperative’s ability to meet short-term obligations. Liquidity refers to the solvency of the firm’s overall financial position – the ease with which it can pay its bills. Because a common precursor to financial distress and bankruptcy is low or declining liquidity, these ratios can provide early signs of cash flow problems and impending business failure. The two basic measures of liquidity are the current ratio and the quick (acid test) ratio (Gitman, 2009).
1. Current ratios
The current ratio is current assets divided by current liabilities. The current ratio measures the firm’s ability to convene its short-term obligations. However, this ratio does not consider the degree of liquidity of each component of current assets. In the other words, if current assets of a cooperative were mainly cash, they would be much more liquid than if comprised of mainly inventory (“Using Financial Ratio Analysis,”1995). Basically, the higher the current ratio, the more liquid is considered to be. If the ratio is less than industry average, current liabilities exceed current assets; it will put the companies liquidity in threatened. Liquidity is actually that in how much time the asset can be converted into cash. Figure 2.1 shows that current ratio for PJV was relatively low for 3 consecutive years from 2007, 2008 and 2009. The current ratio for 2007 was 0.6 and increased to 0.75 in 2008. Although the liquidity rate is growing in case of 2009 to 0.78, it is still below industry average which was stood at 0.84. This is predominantly due to the situation that the company has high current liabilities compared to current asset. The company recorded high current liabilities because they have substantial amount in trade creditor and bank borrowing accounts. Trade creditor recorded at RM
2 Liquidity Ratios
Liquidity ratios measure a business ' capacity to pay its debts as they come due. It also measures the cooperative’s ability to meet short-term obligations. Liquidity refers to the solvency of the firm’s overall financial position – the ease with which it can pay its bills. Because a common precursor to financial distress and bankruptcy is low or declining liquidity, these ratios can provide early signs of cash flow problems and impending business failure. The two basic measures of liquidity are the current ratio and the quick (acid test) ratio (Gitman, 2009).
1. Current ratios
The current ratio is current assets divided by current liabilities. The current ratio measures the firm’s ability to convene its short-term obligations. However, this ratio does not consider the degree of liquidity of each component of current assets. In the other words, if current assets of a cooperative were mainly cash, they would be much more liquid than if comprised of mainly inventory (“Using Financial Ratio Analysis,”1995). Basically, the higher the current ratio, the more liquid is considered to be. If the ratio is less than industry average, current liabilities exceed current assets; it will put the companies liquidity in threatened. Liquidity is actually that in how much time the asset can be converted into cash. Figure 2.1 shows that current ratio for PJV was relatively low for 3 consecutive years from 2007, 2008 and 2009. The current ratio for 2007 was 0.6 and increased to 0.75 in 2008. Although the liquidity rate is growing in case of 2009 to 0.78, it is still below industry average which was stood at 0.84. This is predominantly due to the situation that the company has high current liabilities compared to current asset. The company recorded high current liabilities because they have substantial amount in trade creditor and bank borrowing accounts. Trade creditor recorded at RM