Do Financial Statements Provide The Necessary Information To Determine The Liquidity Of A Company?

Question

Do Financial Statements Provide The Necessary Information To Determine The Liquidity Of A Company?

2 Answers

Answer Question

Answer 1

Financial Statements are very important documents for the organization. They provide the overview of the financial condition of the company through information such as Balance Sheet, Income Statement, Cash flow Statement, Statement of retained earnings etc.

Financial Statements actually do provide the essential information based on which we can determine the liquidity of the company. Liquidity Ratios are the tools used for this purpose. The first Liquidity ratio is Current Ratio which is calculated by dividing the Total current assets with the Total current liabilities. If the answer is 1 or more than 1 than the company is liquid.

The next Liquidity Ratio is Quick Ratio. This is calculated by Dividing the Total Assets -Inventory with Total Liabilities. The answer must be 1 or more than 1.

Another Liquidity Ratio is Debt to Equity Ratio that calculates the leverage of the company against the debt.

Answer 2

Financial statements give the required information for calculation of 2 ratios for analyzing the liquidity position of the company: Fixed charge coverage and cash flow match.

Fixed charge coverage ratio calculates the capacity of the company to meet its interest expense. The ratio is calculated by determining how many times the company’s overall interest expense is met by the net of company operating income less company operating expenses other than interest and taxes. For this ratio it is necessary to know the real dividend payout of a company before final analysis of this ratio.

Cash flow not only covers the interest expenses, but also covers operating expenses and dividends. Cash "sources" are all company operating income plus tax credit. Cash "uses" are operating expenses, dividends to shareholders, and debt principal. A coverage ratio of 1.10 is usually considered good.