The first aspect of measuring the financial stability of a company is liquidity, which measures a company’s ability to convert any assets to cash, and how quickly they are able to do so, in order to meet any financial responsibilities the company must meet. To get a good idea of how liquid a company is, an efficient test would be to compare the company’s current assets and current liabilities, as well as observing the company’s ability to convert account receivables and inventory into cash in a short period of time.
Here are the different ratios used to measure Company 1’s Liquidity:
Company 1 2012 2011
INDUSTRY* Company vs. Industry Trend Current ratio 2.60 2.13 1.82 1.97 Good Good
Quick Ratio 2.56 2.1 1.79 1.71 Good Good
Accounts Receivable Turnover 4.28 4.37 4.36 11.79 Poor Poor
Inventory Turnover 14.75 17.01 16.95 13,466.28 Poor Poor
Analysis of Company 1’s Liquidity:
In the comparison of Company 1’s current assets and liabilities, the current and quick ratios show that the company is doing well in this area. Company 1 is continually increasing each year above the Industry ratio. This means that in both of these ratios, in each year, the ratio is rising and the trend is getting better each year, meaning that for every dollar of liabilities, the amount of assets are increasing by the dollar amount of the ratio.
However, the respective turnover ratios leave much to be desired. They are the complete opposite of the current and quick ratios. They are doing poorly, both in terms of the company versus the industry ratio and the trend versus the industry ratio. These ratios basically mean that the company is holding on the inventory too long, and are not collecting the account receivables quickly. If the company needed cash quickly, they would probably not be able to rely on the inventory and account receivables to be able to be quickly turned into cash.
Here are the different ratios used to measure Company 2’s Liquidity:
Company 2 2012 2011
INDUSTRY* Company vs. Industry Trend Current ratio 2.01 2.74 2.46 1.48 Good Poor
Quick Ratio 1.96 2.7 2.43 1.18 Good Poor
Accounts Receivable Turnover 5.64 6.92 5.28 8.15 Poor Poor
Inventory Turnover 52.51 53.28 41.91 14.76 Good Good
Analysis of Company 2’s Liquidity:
In terms of the industry’s current and quick ratios, Company 2 is doing extremely well. Company 2’s assets are also increasing compared to the liabilities. However, while looking at the trend versus the industry ratios, the trend is not steadily increasing or decreasing, it seems that the ratios are extremely different from each year. While both the current and quick ratio stay well above the industry ratio, both ratios seem a little unstable. The ratios both dip drastically after the year 2009, so that may indicate a variety of things, especially in the economy from 2009 to 2010. The ratios were not terrible, but it would have been hard classifying them as good since they were so unstable.
For Company 2, they seemed to have trouble turning their account receivables into cash, because the ratios for each year were lower than the industry ratios, and the trend suffered the same fate as the quick and current ratios. Company 2 excelled in the years 2008 to 2010 in turning over their inventory, since they were above the industry ratios by a large factor, both in the company and trend versus industry.
Comparison of Company 1 and Company 2’s Liquidity:
Both of these companies are doing a great job at keeping their assets high in terms of the liabilities that they carry. Each of the companies is well above the industry ratios, in terms of the current and quick ratios. Both companies have trouble in turning their account receivables into cash in a timely manner. However, the only difference that the companies had in terms of liquidity was the inventory turnover, where Company 2 is clearly…