By Richard Loth (Contact | Biography)

The first ratios we'll take a look at in this tutorial are the liquidity ratios. Liquidity ratios attempt to measure a company's ability to pay off its short-term debt obligations. This is done by comparing a company's most liquid assets (or, those that can be easily converted to cash), its short-term liabilities.

In general, the greater the coverage of liquid assets to short-term liabilities the better as it is a clear signal that a company can pay its debts that are coming due in the near future and still fund its ongoing operations. On the other hand, a company with a low coverage rate should raise a red flag for investors as it may be a sign that the company will have difficulty meeting running its operations, as well as meeting its obligations.

The biggest difference between each ratio is the type of assets used in the calculation. While each ratio includes current assets, the more conservative ratios will exclude some current assets as they aren't as easily converted to cash.

The ratios that we'll look at are the current, quick and cash ratios and we will also go over the cash conversion cycle, which goes into how the company turns its inventory into cash.

To find the data used in the examples in this section, please see the Securities and Exchange Commission's website to view the 2005 Annual Statement of Zimmer Holdings.

Next: Liquidity Measurement Ratios: Current Ratio »

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