Which one of the following would be more important for a creditor?
Select correct option:
a) Profitability
b) Stability
c) Liquidity
d) Reliability
. Liquidity
Liquidity measures a company's capacity to pay its debts as they come due. There are two ratios for evaluating liquidity.
Current Ratio: The current ratio gauges how capable a business is in paying current liabilities by using current assets only. Current ratio is also called the working capital ratio. A general rule of thumb for the current ratio is 2 to 1 (or 2:1 or 2/1). However, an industry average may be a better standard than this rule of thumb. The actual quality and management of assets must also be considered.
The formula is:
Total Current Assets
_____________________
Total Current Liabilities
Quick Ratio: Quick ratio focuses on immediate liquidity (i.e., cash, accounts receivable, etc.) but specifically ignores inventory. Also called the acid test ratio, it indicates the extent to which you could pay current liabilities without relying on the sale of inventory. Quick assets are highly liquid and are immediately convertible to cash. A general rule of thumb states that the ratio should be 1 to 1 (or 1:1 or 1/1).
The formula is:
Cash + Accounts Receivable
( + any other quick assets )
_____________________
Current Liabilities
Which one of the following would be more important for a creditor?--
Select correct option:
a) Profitability
b) Stability
c) Liquidity
d) Reliability
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Ijaz Shamir
MBA Finance
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