Financial Statements: How To Use Liquidity Ratios

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This is Part 5 of a series on using financial statements for business management. In this video, we'll go through the uses and limitations of commonly used Liquidity Ratios.

The Current Ratio and the Acid Test (Quick) Ratio provide snapshots of the liquidity position of a business at a specific point in time. The Acid Test Ratio is considered a better indicator of liquidity than the Current Ratio because it excludes inventory in the calculation. Inventory is not considered a particularly liquid asset.

However, neither of these 2 Balance Sheet Liquidity Ratios provide information about the quality of the Current Assets or Current Liabilities. So they must be read in conjunction with "quality" ratios like Days Debtors (also called Days Receivable), Days Creditors (also called Days Payable), and Inventory Turnover.

A key limitation of all of these Liquidity Ratios is that the timing dimension is missing. Cash Flow is all about timing. So do not rely on using these ratios for managing Cash Flow.

0:00 Introduction
0:17 Recap: At End Of Month 5
1:37 Month 6:2 Scenarios
2:16 End Of Month 6
2:45 Month 6: Liquidity Ratios
5:53 Days Debtors
7:21 Days Creditors
8:12 Inventory Turnover
8:56 Use Of Liquidity Ratios
10:10 Limitations Of Liquidity Ratios
11:31 Limitations Of Ratios: Cash Flow; Asset Quality
14:56 Summary: Liquidity Ratios