A NOTE ON FINANCIAL RATIO ANALYSIS
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LIQUIDITY RATIOS
Liquidity refers to the ability of a firm to meet its shortterm (usually up to
1 year) obligations. The ratios which indicate the liquidity of a company are
Current ratio, Quick/AcidTest ratio, and Cash ratio. These ratios are
discussed below.
CURRENT RATIO
Current ratio (CR) is the ratio of total current assets (CA) to total
current liabilities (CL). Current assets include cash and bank balances;
inventory of raw materials, semifinished and finished goods; marketable
securities; debtors (net of provision for bad and doubtful debts); bills
receivable; and prepaid expenses. Current liabilities consist of trade
creditors, bills payable, bank credit, provision for taxation, dividends
payable and outstanding expenses. This ratio measures the liquidity of the
current assets and the ability of a company to meet its shortterm debt
obligation. 

Current Ratio = Current Assets /
Current Liabilities
CR measures the ability of the company to meet its CL, i.e., CA gets converted
into cash in the operating cycle of the firm and provides the funds needed to
pay for CL. The higher the current ratio, the greater the shortterm solvency.
While interpreting the current ratio, the composition of current assets must not
be overlooked. A firm with a high proportion of current assets in the form of
cash and debtors is more liquid than one with a high proportion of current
assets in the form of inventories, even though both the firms have the same
current ratio. Internationally, a current ratio of 2:1 is considered
satisfactory.
QUICK OR ACIDTEST RATIO
Quick Ratio (QR) is the ratio between
quick current assets (QA) and CL. QA refers to those current assets that can be
converted into cash immediately without any value dilution. QA includes cash and
bank balances, shortterm marketable securities, and sundry debtors. Inventory
and prepaid expenses are excluded since these cannot be turned into cash as and
when required.
Quick Ratio = Quick Assets / Current Liabilities
QR indicates the extent to which a company can pay its current liabilities
without relying on the sale of inventory. This is a fairly stringent measure of
liquidity because it is based on those current assets which are highly liquid.
Inventories are excluded from the numerator of this ratio because they are
deemed the least liquid component of current assets. Generally, a quick ratio of
1:1 is considered good. One drawback of the quick ratio is that it ignores the
timing of receipts and payments.
CASH RATIO
Since cash and bank balances and short term marketable securities are the
most liquid assets of a firm, financial analysts look at the cash ratio. The
cash ratio is computed as follows:
Cash Ratio = (Cash and Bank Balances + Current Investments) / Current
Liabilities
The cash ratio is the most stringent ratio for measuring liquidity.
OPERATIONAL/TURNOVER RATIOS
LEVERAGE/CAPITAL STRUCTURE RATIO
PROFITABILITY RATIOS
VALUATION RATIOS
CALCULATING FINANCIAL RATIOS OF HLL
COMMON SIZE INCOME STATEMENT OF HLL
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