Trade creditors; creditors for expenses; commercial banks; short-terms lenders
are concerned with the short-term financial position or liquidity of the unit.
Management is also interested in knowing how efficiently working capital is
being utilized by the business. Shareholders and long-term creditors are also
interested in studying the prospectus of dividend and interest payment.
Liquidity ratios measure the ability of the unit to meet its short-term
(generally one year) obligations and reveals the short-term financial strength
Such ratios provide answer to questions like:
(a) Is the unit capable to meet short-term obligation?
(b) Is working capital being properly utilized?
(c) is the current financial position improving?
Two types of ratios are calculated for testing short-term financial position
of the business,
liquidity ratios and current assets movement or efficiency ratios:
Liquidity ratios usually consist of:
(i) Current ratio
(ii) Acid test or quick or liquid ratio and
(iii) Absolute liquid ratio or cash position ratio.
Activity/efficiency ratios usually consist of:
(i) Inventory/Stock Turnover Ratio
(ii) Debtors /
Receivable Turnover Ratio
(iii) Creditors /
Payables Turnover Ratio
(iii) Working Capital Turnover Ratio