What is the most stringent measure of corporate liquidity?
The cash ratio is the most stringent of all Liquidity Ratios and measures a company's ability to pay off its short-term debt with only cash or cash equivalents.
The two most common metrics used to measure liquidity are the current ratio and the quick ratio. A company's bottom line profit margin is the best single indicator of its financial health and long-term viability.
The best answer is D. The cash assets ratio is the ratio of cash to current liabilities; this is the most stringent test of liquidity.
The cash ratio is the strictest measure of a company's liquidity because it only accounts for cash and cash equivalents in the numerator.
The current ratio is the simplest liquidity ratio to calculate and interpret. Anyone can easily find the current assets and current liabilities line items on a company's balance sheet. Divide current assets by current liabilities, and you will arrive at the current ratio.
Liquidity ratios measure a company's ability to pay debt obligations and its margin of safety through the calculation of metrics including the current ratio, quick ratio, and operating cash flow ratio.
- Current Ratio = Current Assets / Current Liabilities.
- Quick Ratio = (Cash + Accounts Receivable) / Current Liabilities.
- Cash Ratio = (Cash + Marketable Securities) / Current Liabilities.
- Net Working Capital = Current Assets – Current Liabilities.
Quick Ratio Analysis
Other important liquidity measures include the current ratio and the cash ratio. The quick ratio is a stricter measure of liquidity than the current ratio because it includes only cash and assets the company can quickly turn into cash.
The most stringent and conservative of all liquidity ratios is the cash ratio, which takes into account only a company's cash, cash equivalents, and marketable securities among its current assets. A company with a high cash ratio has a very strong liquidity position.
The current ratio is the ratio of all current assets to current liabilities. This is the least stringent test of liquidity.
Which of the following is the most stringent test of liquidity taken from a corporation's balance sheet?
Explanation: The most stringent test of liquidity taken from a corporation's balance sheet is the cash ratio. The cash ratio measures a company's ability to pay off its current liabilities using only its cash and cash equivalents.
The correct answer is b. Receivable Turnover. Receivable turnover is a measure of liquid...
Liquidity measures can be classified into four categories: (i) transaction cost measures that capture costs of trading financial assets and trading frictions in secondary markets; (ii) volume-based measures that distinguish liquid markets by the volume of transactions compared to the price variability, primarily to ...
| Liquidity Ratios | Formula |
|---|---|
| Current Ratio | Current Assets / Current Liabilities |
| Quick Ratio | (Cash + Marketable securities + Accounts receivable) / Current liabilities |
| Cash Ratio | Cash and equivalent / Current liabilities |
| Net Working Capital Ratio | Current Assets – Current Liabilities |
Investors, lenders, and managers all look to a company's financial statements using liquidity measurement ratios to evaluate liquidity risk. This is usually done by comparing liquid assets—those that can easily be exchanged to create cash flow—and short-term liabilities.
- The current ratio or working capital. This compares current assets, including inventory, and liabilities.
- The acid test, or quick ratio. This measures only current assets, such as cash equivalents, against liabilities.
- The cash ratio or net working capital.
Debt to assets ratio. This is not a liquidity ratio but a solvency ratio. It is computed by dividing the total liabilities by total assets indicating the level of assets financed by the debt. All the other options including current ratio and working capital measure the liquidity of a firm.
The three main liquidity ratios are the current, quick, and cash ratios. The current ratio is current assets divided by current liabilities. The quick ratio is current assets minus inventory divided by current liabilities. The cash ratio is cash plus marketable securities divided by current liabilities.
Current, quick, and cash ratios are most commonly used to measure liquidity.
The quick ratio offers a more conservative view of a company's liquidity or ability to meet its short-term liabilities with its short-term assets because it doesn't include inventory and other current assets that are more difficult to liquidate (i.e., turn into cash).
Why is the quick ratio a more appropriate measure of liquidity than?
Why is the quick ratio a more appropriate measure of liquidity than the current ratio for a large-airplane manufacturer? It recognizes the contribution of all assets so that analysts can see how "quickly" a firm can satisfy its short-term obligations. It recognizes that parts can be quickly converted to cash.
The current ratio measures a company's ability to pay off its short-term liabilities with its current assets, while the quick ratio is more conservative as it excludes inventories and only considers cash and cash equivalents, accounts receivable, and short-term marketable securities.
The bottom line
Both ratios are helpful for any financial analysis, but if you're more concerned with covering short-term debt within the next 90 days you should use the quick ratio. For a longer-term view of a company's liquidity, the current ratio provides a well-rounded view of assets vs liabilities.
This ratio is considered more stringent or conservative than the current ratio because it excludes inventory, which may not be easily converted into cash. On the other hand, the current ratio includes all current assets, including inventory, in its calculation.
The most precise test of liquidity is 'Absolute liquid ratio'.
