Different companies operate under different liquidity conditions due to the factors affecting them or due to the nature of the industry they operate in.
An analyst will use various liquidity and other ratios to determine the firm’s liquidity position and to compare it with its peers or industry standards.
The important ratios are:
Click the links below to learn more about these ratios
- Current ratio, quick ratio and cash ratios
- Receivables Turnover and Days of Sales Outstanding (DSO)
- Payables Turnover and Number of Days of Payables
- Inventory Turnover and Days of Inventory on Hand (DOH) –
Evaluating Working Capital Effectiveness
The analyst can also evaluate the effectiveness of the firm’s working capital. There are two tools to do so.
1. Operating Cycle:
Operating Cycle refers to the number of days it takes to convert raw material into cash. It is calculated as the sum of days of inventory and days or receivables.
2. Cash Conversion cycle:
Cash conversion cycle refers to the number of days it takes to convert the cash invested in business back to cash.
Cash Conversion Cycle = Average days of receivables + Average days of inventory – Average days of payables.
A high cash conversion cycle is undesirable.
Learn more about Cash Conversion Cycle.