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Contents
Ration Analysis: .................................................................................................................... 3
Short-term solvency ratio: ................................................................................................... 3
Importance of Short-Term Solvency Ratio: ......................................................................... 4
The most common Short-term solvency ratios are: ........................................................... 4
Current ratio: .................................................................................................................... 5
Quick ratio: ....................................................................................................................... 5
Cash/Super quick ratio: .................................................................................................... 6
Problems & Solutions: 1 ...................................................................................................... 7
Current Ratio: ................................................................................................................... 8
Outcomes: ..................................................................................................................... 9
Net working capital: ......................................................................................................... 9
outcomes: ...................................................................................................................... 9
Quick Ratio:....................................................................................................................... 9
Outcomes: ..................................................................................................................... 9
Super Quick Ratio: .......................................................................................................... 10
Outcomes: ................................................................................................................... 10
Problems & Solutions: 2 .................................................................................................... 11
Current Ratio: ................................................................................................................. 11
Outcomes: ................................................................................................................... 12
Net working capital: ....................................................................................................... 12
Outcomes: ................................................................................................................... 12
Quick Ratio:..................................................................................................................... 12
Outcomes: ................................................................................................................... 12
Super Quick Ratio: .......................................................................................................... 13
Outcomes: ................................................................................................................... 13

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Ration Analysis:
Effective planning and financial management are the keys to running a financially
successful small business. Ratio analysis is crucial for helping an individual to
understand the financial statements, for identifying trends over time and for
measuring the overall financial state of different kind of business. Additionally,
lenders and potential investors often rely on ratio analysis when making lending and
investing decisions. Besides, Ratios are critical quantitative analysis tools. One of
their most important functions lies in their capacity to act as lagging indicators in
identifying positive and negative financial trends of different organizations. It
creates benchmarks of the performance of all industry players can be measured.
Small businesses can use industry benchmarks to craft organizational strategy and
clearly measure their own performance against the industry as a whole. This trend
analysis allows to managers to make and implement ongoing financial plans and,
when necessary, make course corrections to short-term financial plans. Ratio
analysis also grant options for manager to evaluate the financial status of business
aligned with other businesses within your industry or between other industries.
This process can be both long-term and short term for understanding the financial
states of a business for the shorter and longer periods. Short-term solvency ratios are
the medium to analysis the short-term financial status of different businesses.

Short-term solvency ratio:

Solvency ratio is a key metric used to measure an enterprise’s ability to meet its debt
and other obligations for short term. The solvency ratio indicates whether a
company’s current assets is sufficient enough to meet its short-term and long-term
liabilities. The lower a company's solvency ratio, the greater the probability that it
will default on its debt obligations.

Short-term solvency ratios attempt to measure the ability of a firm to meet its short-
term financial obligations. In other words, this ratios seek to determine the ability of
a firm to avoid financial distress in the short run. In fact, liquidity is a qualification
for survival of a organization. The short-term investors, creditors of a firm are
interested in the short-term solvency or liquidity of a firm. But Liquidity implies,

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from the view point of utilization of the funds of the firm that funds are idle or they
earn very little. A proper balance between most current assets and short term debt
that implies liquidity and profitability, is required for efficient financial
management. Short-term solvency ratio imitates the short-term financial
strength/solvency of a firm.

Importance of Short-Term Solvency Ratio:

 Short-term solvency ratio is only one of the metrics used to determine whether
a company can meet its financial obligations.
 Investor need to know the current progress of the organization which requires
to analysis the short-term solvency ratios.
 To attract the creditor’s organization need to disclose its short-term solvency
ratios. Attractive short-term solvency ratio increase the interest of creditor
which can helps to get credits if necessary.
 It is important to evaluate the current progress of the organization. Based on
the analysis, managers justify the current track of the organization, brings
change in the operation if requires.
 In term of the need of Bank loans, it is important to analysis short-term
solvency ratio to understand the current growth of an organization.

The most common Short-term solvency ratios are:

1. Current/ Working Capital Ratio.

2. Quick/Acid test ratio

3. Super Quick/Cash Ratio.

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Current ratio:

The current ratio/Net working capital ratio is a liquidity ratio that measures a
company's ability to pay short-term and long-term obligations. To measure this
ability, the current ratio considers the total current assets of a company relative to
that company’s current total liabilities. Current ratio is calculated by dividing current
asset by current liabilities. Current assets are the assets that the firm expects to
convert into cash and current liability represent the liabilities which have to be paid
in cash in the current accounting periods. As such, current ratio can be used to make
a rough estimate of a company’s financial health. The current ratio can give a sense
of the efficiency of a company's operating cycle or its ability to turn its product into
cash.

Current Assets
Current Ratio/Net Working Capital Ratio =
Current Liabilities

Tracking the current ratio helps an investor assess the health of a company. A
higher current ratio is always more favorable than a lower current ratio because it
shows the company can more easily make current debt payments. A ratio over 1
indicates that a company’s assets are greater than its liabilities and suggests that
the company in question would be able to pay off its obligations if they came due
at that point. Which states the company is in good financial health. Whereas, a
lower current ratio is not favorable for an organization. A ratio under 1 indicates
that a company’s liabilities are greater than its assets and suggests that the
company in question would be unable to pay off its obligations if they came due
at that point. While a current ratio below 1 shows that the company is not in good
financial health.

Quick ratio:

The quick ratio or acid test ratio is a liquidity ratio that measures the ability of a
company to pay its current liabilities when they come due with only quick assets.
Quick assets are current assets that can be converted to cash within in the short-
term or within a year. Cash, cash equivalents, short-term investments or

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marketable securities, and current accounts receivable are considered quick assets.
Quick ratio states more liquid than current ratio as we deduct inventory from the
current assets. Quick ratio is a measurement of a firm’s ability to convert its
current asset quickly into cash in order to meet its current liabilities. Basically,
quick ratio is a measure of how well a company can meet its short-term financial
liabilities. Also known as the acid-test ratio, it can be calculated as follows:

(Current assets-Inventory-Prepaid Expense)

Quick Ratio =
Current Liabilities

The acid test ratio measures the liquidity of a company by showing its ability to pay
off its current liabilities with quick assets. If a firm has enough quick assets to cover
its total current liabilities, the firm will be able to pay off its obligations without
having to sell off any inventories or long-term or capital assets. Since most
businesses use their long-term assets to generate revenues, selling off these capital
assets will not only hurt the company it will also show investors that current
operations aren’t making enough profits to pay off current liabilities.

Higher quick ratios are more favorable for companies because it shows there are
more quick assets than current liabilities. A company with a quick ratio of 1 indicates
that quick assets equal current assets. This also shows that the company could pay
off its current liabilities without selling any long-term assets. An acid ratio of higher
than 2 shows that the company has twice as many quick assets than current liabilities.

Cash/Super quick ratio:

Super quick ratio shows how well a company can pay off its current liabilities with
only cash and cash equivalents. Cash ratio is an even more conservative ratio since
it considers cash and marketable securities only. The cash ratio is the ratio of a
company's total cash and cash equivalents to its current liabilities. Cash equivalents
are assets which can be converted into cash quickly whereas current liabilities are
those liabilities which are to be settled within a year or the business cycle. The metric

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calculates a company's ability to repay its short-term debt. Cash/super quick ratio
states the most liquid than any other short term solvency ratio as we keep only cash
and cash equivalent only. The cash ratio is most commonly used as a measure of
company's liquidity. If the company is forced to pay all current liabilities
immediately, this metric shows the company's ability to do so without having to sell
or liquidate other assets. Cash equivalents are assets which can be converted into
cash quickly whereas current liabilities are those liabilities which are to be settled
within 12 months or the business cycle.

Cash + Cash Equivalents

Cash Ratio =
Current Liabilities

If a company's cash ratio is equal to 1, the company has exactly the same amount of
current liabilities as it does cash and cash equivalents to pay off those debts.

If a company's cash ratio is less than 1, there are more current liabilities than cash
and cash equivalents. In this situation, there is insufficient cash on hand to pay off
short-term debt.

If a company's cash ratio is greater than 1, the company has more cash and cash
equivalents than current liabilities. In this situation, the company has the ability to
cover all short-term debt and still have cash remaining. A cash ratio of 1.00 and
above means that the business will be able to pay all its current liabilities in
immediate short term. Therefore, creditors usually prefer high cash ratio. But
businesses usually do not plan to keep their cash and cash equivalent at level with
their current liabilities because they can use a portion of idle cash to generate profits.
So, this means that a normal value of cash ratio is somewhere below 1.0

Problems & Solutions: 1

Information of ABC Incorporation
Year ending December 31, 2017

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 Amount
Cash 80,000
Account Receivables 70,000
Inventories 70,000
Notes Payable 35,000
Account Payable 70,000
Marketable Securities 10,000

 Calculate Current Ratio and analysis the current condition of ABC

incorporation.
 Calculate Net working capital.
 Calculate Acid test Ratio and analysis the current condition of ABC
incorporation.
 Calculate super quick ratio and analysis the current condition of ABC
incorporation.

Current Ratio:

Current assets= (Cash +Account Receivables+ Inventories+ Marketable Securities)

= (80,000+70,000+70,000+10,000) BDT.
=230,000 BDT.

Current Liabilities= (Notes Payable +Account Payable)

= (35,000 + 70,000) BDT
=105,000 BDT

Current Assets
Current Ratio/Net Working Capital Ratio =
Current Liabilities

230,000
=
105,000

=2.19 times

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Outcomes:
The current ratio is 2.19 which means the company’s current assets are more than
2 times more than its current liabilities. Current ratio is 2.19:1 which is considered
satisfactory.

Net working capital:

Net working capital= (Current assets- Current Liabilities)

= (230,000-105,000) BDT
=125,000 BDT

Outcomes:
The net working capital is 125,000 BDT. ABC incorporation has enough working
capital to continue its current operation.

Quick Ratio:
(Current assets-Inventory)
Quick Ratio =
Current Liabilities

(230,000-
= 70,000)
105,000
= 1.524 times

Outcomes:
The Acid test ratio is 1.524 which means the company’s quick assets are more
than 1.5 times more than its current liabilities. Current ratio is 1.524:1 which is
considered satisfactory.

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Super Quick Ratio:

Cash + Marketable Securities

Cash Ratio =
Current Liabilities

80,000 + 10,000
=
105,000

=0.857 times

Outcomes:
Cash Ratio is 0.857 times to its current liabilities. This test is more rigorous
measure of a firm’s liquidity position. But here super quick ratio is 0.857:1 that
indicates the firm has not enough cash in hand to meet all current liabilities.
Though it is this means that a normal value of cash ratio is somewhere below 1.00.
As businesses usually do not plan to keep their cash and cash equivalent at level
with their current liabilities because they can use the portion of idle cash to
generate profits. So the situation is still satisfactory, as super quick ratio is very
close to 1.

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Problems & Solutions: 2
Information of Sarker Incorporation
Year ending December 31, 2017

Amount
Cash equivalents 50,000
Account Receivables 35,000
Inventories 105,000
Notes Payable 75,500
Account Payable 135,500
Treasury Bills 18,500

 Calculate Net working capital.

 Calculate Current Ratio and analysis the current condition of Sarker Inc.
 Calculate Acid test Ratio and analysis the current condition of Sarker Inc.
 Calculate Super quick ratio and analysis the current condition of Sarker Inc.

Current Ratio:

Current assets= (Cash equivalent +Account Receivables+ Inventories+ Treasury

Bills)
= (50,000+35,000+105,000+18,500) BDT.
=208,500 BDT.

Current Liabilities= (Notes Payable +Account Payable)

= (75,500 + 135,500) BDT
=211,000 BDT

Current Assets
Current Ratio/Net Working Capital Ratio =
Current Liabilities

208,500
=
211,000

=0.988 times

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Outcomes:
The current ratio is 0.988 which means the company’s current assets are less than
its current liabilities. Current ratio is 0.988:1 which is considered as not
satisfactory.

Net working capital:

Net working capital= Current assets- Current Liabilities)

= (208,500-211,000) BDT
= (2500) BDT

Outcomes:
The net working capital is (2500) BDT. Sarker incorporation has no working capital
to continue its current operation. It is alarming for the organization as it depends on
its liabilities to continue its operations.

Quick Ratio:
(Current assets-Inventory)
Quick Ratio =
Current Liabilities

(208,500-105,000)
=
211,000
= 0.49 times

Outcomes:
The Acid test ratio is 0.49 which means the company’s quick assets are less than
its current liabilities. Current ratio is 0.49:1 which is considered as not
satisfactory.

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Super Quick Ratio:

Cash + Marketable Securities

Cash Ratio =
Current Liabilities

50,000 + 18,500
=
211,000

=0.32 times

Outcomes:
Cash ratio is 0.32 times to its current liabilities. This test is more rigorous
measure of a firm’s liquidity position. But here super quick ratio is 0.32:1 that
indicates the firm has not enough cash in hand to meet all current liabilities.
Though it is this means that a normal value of cash ratio is somewhere below
1.00. But in this situation cash ratio is very low. So the situation is not
satisfactory, as super quick ratio is very far from 1.

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