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Liquidity ratios are the ratios that measure the ability of a company to meet its short term debt obligations.

These ratios measure the ability of a company to pay off its short-term liabilities when they fall due.

Generally, the higher the liquidity ratios are, the higher the margin of safety that the company possesses to meet its current liabilities.

Liquidity ratios greater than 1 indicate that the company is in good financial health and it is less likely fall into financial difficulties.

Most common examples of liquidity ratios include current ratio, acid test ratio (also known as quick ratio), cash ratio and working capital ratio. Different assets are considered to be relevant by different analysts.

Some analysts consider only the cash and cash equivalents as relevant assets because they are most likely to be used to meet short-term liabilities in an emergency. Some analysts consider the debtors and trade receivables as relevant assets in addition to cash and cash equivalents. Some analysts also consider the value of inventory.

A company must possess the ability to release cash from cash cycle to meet its financial obligations when the creditors seek payment.

In other words, a company should possess the ability to translate its short-term assets into cash.

The liquidity ratios attempt to measure this ability of a company.

From India, Ahmadabad
Sagar: I could not understand the intention of this post in a HR forum like this one. How relevant it is for HR members to know about acid test ratio & the like ?
From India, Mumbai
Dear Mr.Dixon,
May be it may be irrelevant to some members but such inputs may be useful to other members who are handling wage negotiations (company's financial position, capacity to pay etc.,) will find this useful. It will also be relevant to members who handle Wage and Salary administration which involves decisions relating to percentage to be offered as increments. Sustaining the capacity to pay being the key, such information will throw light on crucial decisions.
It will also be useful for those HR personnel who are at the helm of affairs in recruitment. Such questions can be posed to the candidates to find out their knowledge levels during a preliminary round for a finance position.
Thanks Mr.Sagar for the input provided. I found it useful.

From India, Madras
Mr Kannan, will you be in a position to explain the usefulness of these ratios with the help of some examples to enable HR fraternity to understand their utilization in planning HR budgets for the organization.
From India, Delhi
Dear Mr.Bhatia,

I shall share the little knowledge I possess with the HR fraternity. HR budget involves cash flow projections for the whole financial year. Companies follow different types of budgeting Top down budgeting, Bottom up budgeting, Zero based budgeting and Flexible budgeting.

The cash flow projections could include the proposed manpower additions and the cost involved in such an exercise, welfare or fringe benefits the company proposes to spend during the year, leave encashment liability, Gratuity payout if any during the year, Superannuation benefits if any, insurance premiums payable for employee benefits, legal expenditure the company has to incur during the year for fighting a case in the court of law, increase in boarding and lodging expenses for travel of employees for official purposes, LTA payment, Medical reimbursement payments, cost of printing and stationery, security provisions, capex expenditure involved, logistic support provided for employees etc.,

Once these projections reach the finance department they work out the resources needed to meet the budgets. Based on the company's financial status the budget is trimmed to manage the cash flow. In some companies the cash flow is sought from different departments on a monthly basis.

Operations chips in with the quantity is likely to dispatch with values, materials gives input regarding inventory holding and Marketing indicates that the orders it is likely to book and collections it can generate during the month. With this finance plans its activity.

In other words the finance department strives to maintain the ratio greater than one to sustain and pay all the commitments given to all departments.



From India, Madras
Thanks for your enlightened input establsihing a relation between the need for liquidity and the liability of HR to discharge certain sudden pecuniary liabilities. Some times, a company may recieve an order from a court to deposit a certain amount which may run into few lakhs during pendency of an appeal or it may recive an order from a court to pay back wages running into few lakhs ofr it's illegal terminationn specifying a time limit to discharge it's liability. these liabilities cannot be postponed but to be complied within a time frame. A company with sound liquidity can only meet sudden financial contingencies.
HR&Labour Law advisor

From India, Mumbai
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