Calculate and Interpret Liquidity and Solvency Ratios

Introduction

Ratio analysis can assist with the conduct of time-series and cross-sectional analysis of a company’s financial position.

Balance sheet ratios are those ratios which involve balance sheet items only and include (i) liquidity ratios, which measure a company’s ability to meet short-term obligations; and (ii) solvency ratios, which measure financial risk, financial leverage and a company’s ability to satisfy its long-term and other obligations.

Computation of liquidity and solvency ratios

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Question 1

The following balance sheet information is given for company XYZ.

Company XYZ balance sheet

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Which of the following is the current ratio for company XYZ?

A. 0.67

B. 0.34

C. 1.20

Solution

The correct answer is A. Current ratio = 2,557,034/3,825,396 = 0.67.

Question 2

Kylee Co. reported the following information on its latest balance sheet.

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According to the information provided, the current ratio of Kylee Co. is closest to:

A. 3.67

B. 4.72

C. 4.33

Solution

The correct answer is C.

Current ratio = Current assets/Current liabilities

The only current assets reported on the balance sheets are cash and accounts receivables. The only current liability reported above is accounts payable.

Current ratio = (Cash + Accounts receivable)/Accounts payable = (50 + 80)/30 = 4.33

 

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Calculate and interpret liquidity and solvency ratios

 

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