CFA Level 1 | Financial Analysis |  Letslearn Global | CPA CMA CFA coach
Channel: LetsLearn Global
Date: 2022-05-13

CFA Level 1 | Financial Analysis |
Financial ratios are used to express one financial quantity with reference to another. Financial ratios can assist with company and security valuations, as well as stock selections, and forecasting.

A variety of categories may be used to classify financial ratios. Although the names of these categories and the ratios that are included in each of them can vary significantly, common categories that are used include activity, liquidity, solvency, profitability, and valuation ratios.  Each category measures a different aspect of a company’s business. However, all categories are important in the evaluation of a company’s overall ability to generate cash flows from its business operations.

Liquidity ratios measure a company’s ability to satisfy its short-term obligations. These ratios reflect a company’s position at a point in time. They, therefore, usually use ending balance sheet data rather than averages. The list below describes the most commonly used liquidity ratios.

Current Ratio

Computation: current assets/current liabilities

Interpretation: a higher current ratio indicates a higher level of liquidity or ability to meet short-term obligations.

Quick Ratio

Computation: (cash + short-term marketable investments + receivables)/current liabilities

Interpretation: a higher quick ratio indicates a higher level of liquidity or ability to meet short-term obligations. It is a better indicator of liquidity than the current ratio in instances where inventory is illiquid.

Cash Ratio

Computation: (cash + short-term marketable investments)/current liabilities

Interpretation: the ratio is a reliable measure of liquidity in a crisis.

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