The Importance Of Liquidity

Today, businesses need to utilize many tools to maximize profit and stay alive in the market. Several companies often look at financial ratios to better understand a company’s financial condition and their performance. All of the ratios play a large role in these companies, both individually, as well as collectively.

There are several financial ratios which all calculate different things important to a business. Liquidity ratios measure the firm’s ability to meet short term obligations. It is important for a company to have good liquidity, which shows that the company has capital to pay expenses. The greater a company’s liquidity, may mean that it has less money tied up in assets. Activity ratios measure a firm’s utilization of assets. Assets

Liquidity ratios can help show whether or not a company has enough cash to pay short term expenses to keep a company going. If there is a serious lack of liquidity, a company may need to convert some assets to cash or obtain more cash through certain means. Activity ratios can help someone understand the reason for a failing business through viewing possible changes in common use resources. In understanding the leverage and coverage ratios, there can be a greater ability to see if the company is taking on too much financial risk and if the company is able to sustain itself in servicing its debt. Profitability ratios show a company’s performance and condition through how much money the company has made after expenses. If the ratio reflects a low number, or negative number, things need to change. I believe these ratios are related because they all tie in to profitability and sustainability. I believe for a business to be successful, it needs to be profitable, which ties into many of these ratios listed. It also need to be sustainable, which plays into all of these ratios listed. To be the most profitable, a company will need to have good activity ratios, utilization of assets, good leverage and coverage ratios, the ability to finance and service debt, and have decent liquidity ratios showing that the company can meet short term obligations. All of these ratios support

Members of a firm such as financial managers and accountants, prospective and current investors, prospective creditors, and accounting students, as well as many more people who may use these ratios. Although all persons listed above might use these ratios, they may have different motives for calculating these ratios. These ratios, when applied to different people, continually have the same meaning behind what they represent and stand for. All who calculate these ratios most commonly are looking to assets the company’s financial standing and position. The firm itself will be looking to find weak points in the business and see where and what changes need to be made.The firm looks for internal control purposes within the budgetary process and isolate problems before they get too big. The accountant uses these ratios to calculate information for other members of the firm to be able to interpret the company’s standing. Prospective and current investors may use these ratios to look into companies they have invested in or plan on investing in, to see what may be a proper investment, based on liquidity, potential, value and earnings. Prospective creditors would use these ratios to determine payback ability. Accounting students may use these ratios to simply crunch numbers, it does not have meaning besides where and when the calculation is applied. Many people can use these ratios if they have proper information to understand how well a