Question

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Liquidity Ratios are important in analysis of daily management financial and operational strategic plans (tine less than one year). How would this type of analysis impact your project analysis if you monitored projects that you implemented with funds available

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Answer 1

Liquidity ratios help to assess a business's capacity to meet immediate & current obligations , with the current assets available, in the form of cash or that which can be converted to cash , as quickly as possible, in the event of exigencies or any unforeseen development/s.

Both the main liquidity ratios --current and quick ratio --are calculated from the current assets and the current liabilities , that appear on the balance sheet of a business. Both tell about the short-term solvency of the business--ie. How smoothly or efficiently the core business operations are carried on , with the available working capital.

This working capital, otherwise called operating capital ,is normally

in the form of cash, accounts receivables on revenues made, prepaid assets,merchandise inventory,

the total of which is reduced by payables and other business accruals--which also provide working capital to the business in the form of trade credits.

Current ratio(Current asset/Current liabilities) measures all the less-than-a year (current) liabilities against all the less-than-a year ( current ) assets , to see if the former can be adequately paid/settled, in any exigency, by encashing the current assets--ie. The liabilities have dequate cushion.Ideal cushion required by analysts is 2 , ie.current assets should be 2 times the current liabilities.

The quick ratio ( Current asset-Inventory& prepaid assets)/Current liabilities) measures all the less-than-a year (current) liabilities against all the even more liquid ( current ) assets ,leaving out inventory & the already pre-paid assets -- to see if the former can be adequately paid/settled, in any exigency, by encashing them.--Ideal cushion required by analysts is 1 , ie.the quick assets should equal to the current liabilities.

A person operating on a project,with limited funds , while analysing the liquidity ratios , must be aware that too high a current /quick ratio may mean , opportunity cost of interest lost on funds , that are locked up in either unsold inventories or uncollected receivables.

Inventories should be carried at such an optimal level , so as not to lose on customers who come for the product.

Similarly, credit policies reviewed & receivables ,be collected on time , so that cash may be re-invested in the project or invested in profitable short-term invetsments.

Too,low a current ratio may mean very low current assets &also runs the risk of vendors refusing to extend further credits, which may delay the project further .Under such circumstances, settling -off of vendor bills will improve this ratio to a certain extent--otherwise, we may end up in resorting to long-term borrowing to settle these trade (short-term,less-than-a-year) debts.

Thus, liquidity ratios are a means to assess the assets & liabilities created by the core operations under a project.

It serves as an effective tool to see in what direction the project is progressing.

Normally projects are for a short-period of time .

By proper classification and analysis of the components of the assets and liabilities created by the project, the entrepreneur will be able to allocate and use funds efficiently , in executing the project.