Basic Finance 1 - Liquidity ratios

Calculating liquidity ratios

This is a very quick post to show how to calculate the four main liquidity ratios, one of the most important groups of financial ratios.

We use financial ratios to evaluate a firm’s performance, a firm’s financial capacity, or any other financial-related information we want.

I don’t want to go into much detail about financial ratios; let’s go straight to practice.

I am going to use data from Magazine Luiza, one of the hottest stocks at the moment in Brazil. You can download the data from here to get the same results. But the source of this spreadsheet is the website I can’t be sure this site is always correct. But in all the times that I checked, I’ve never found an error.

These are the top four liquidity ratios for this company in the last quarter (2nd quarter of 2020).

This is the Cash ratio:

$$Cash\ Ratio = \frac{Cash\ and\ Cash\ equivalents}{Current\ Liabilities} = 0.12$$

This is the Cash ratio (with short-term investments):

$$Cash\ Ratio\ (STI) = \frac{Cash\ and\ Cash\ equivalents + Short\ term\ investments}{Current\ Liabilities}= 0.31$$

This is the Acid test ratio:

$$Acid\ test\ Ratio = \frac{Current\ Assets - Inventories}{Current\ Liabilities} = 0.95$$

This is the Current ratio:

$$Current\ Ratio = \frac{Current\ Assets}{Current\ Liabilities} = 1.39$$

And below, you can see the evolution of these four rations. Notice that the X-axis is inverted, so we need to look at the evolution from right to left (see the axis' legend).

All ratios seem pretty stable to me. We can notice some increase in the Current ratio in the first quarter of 2020, but it is already back to normal.

I will continue this series of indicators. We are going to see Leverage ratios, Profitability ratios, Working Capital ratios, Valuation rations, Operating returns ratios, Interest Coverage ratios, and some others.

I hope you like this series. Thanks!

Henrique Castro Martins
Henrique Castro Martins
Assistant Professor of Finance