Question

In general, which is better, high liquidity ratio values or low liquidity ratio values? Is it possible for the current and quick ratio values to get too large? How might this occur? What problem does it indicate the firm may be experiencing?​

Answer 1

It is extreme important for a firm to able to meet its obligation as they become due. liquidity ratio measures the ability of the firm to meet its current obligations(liabilities).A firm should ensure that it does not suffer from lack of liquidity and also that it does not have excess liquidity. The higher the ratio, the more liquid the company is. Low values indicate that a firm may have difficulty meeting obligations.

All other things being equal, In general point of view a high liquid ratio to be better than a low liquid ratio, because a high liquid ratio means that the company is more likely to meet its liabilities which are due .

In general, low or decreasing ratios generally suggest that a company is over-leveraged, struggling to maintain or grow sales, paying bills too quickly or collecting receivables too slowly. On the other hand, a high or increasing ratio generally indicates that a company is experiencing solid top-line growth, quickly converting receivables into cash, and easily able to cover its financial obligations. Such companies often have faster inventory turnover and cash conversion cycles.

Since the circumstances for every business and industry are different, making it difficult to create a universal benchmark for healthy liquidity ratios. The best practice for investors, lenders and managers is to consider liquidity ratios of successful competitors and historical trends.

                                             In general terms the current ratio of 2 to 1 is considered satisfactory and quick ratio of1 to 1 is considered to represent a satisfactory current financial condition. It is possible to have higher values of current and quick ratio but the higher value of these ratio indicates that that the business managers is unable to find investment opportunities .A higher degree of liquidity is also bad as idle asset earns nothing, the firms fund will be unnecessary tied up in current asset.