 In this section, I will explain the two frequently used liquidity ratios and these are the current ratio and the quick ratio. So if we look at the first one, the current ratio, it basically measures the company's ability to pay off its current liabilities that are payable within one year. So immediately you have to calculate the current ratio within one year. Now if we want to calculate the value of the current ratio, you need to have the value for the current assets and this will be divided by the total value of the current liabilities. So by current, we mean that whatever is available for one year, current liabilities and current assets, it means that immediately the assets of one year and the liabilities of one year are being accounted for to calculate the current ratio. Now the second type of liquidity ratio is called the quick ratio or the asset test ratio. Quick ratio basically measures the company's ability to meet its short term obligations with its most liquid assets and therefore it excludes the inventories from its current assets. So when you have to calculate the value of the current assets, then you exclude the inventories from it. Hence the name of this ratio is called the quick ratio or the asset test ratio. Now to calculate the quick ratio, you should have the value of cash and cash equivalents. After that you should have the value of marketable securities and then you are going to have the value for the accounts receivable. By collecting these three, you will have total current assets. Now you have to deduct the value of the inventories from the current assets. Otherwise the current ratio will be deducted from the current ratio. So we have deducted the inventories from it and then you are going to divide this number by current liabilities and you will be able to find out the value for the quick ratio. Now how do we interpret this? I am going to explain it with the help of an example. Suppose we have two hypothetical companies. One name is ABC Incorporation and the other name is XYZ Company. Now both of them have assets or liabilities on their balance sheet and all the values are given in millions of dollars. I am going to show you these numbers and we are assuming that these two companies are operating in the same manufacturing sector. Both of them are manufacturing and fall in the same sector. That is why we discussed that this sector should be the same if you are going to compare the equity ratios so that you can do better analysis. Now in this example we have taken ABC Incorporation and XYZ Company. So they have a view of the balance sheet and ABC has a cash of 5 million dollars. They have marketable securities of 5 million dollars and XYZ has marketable securities of 2 million dollars. They have a cash of 1 million dollars. Similarly ABC has 10 million dollars accounts receivable while XYZ has 2 million dollars accounts receivable. We have counted the inventories and took the value of the current assets. We have taken plant and equipment and intangible assets. Now you have to collect the plant and equipment and intangible assets. So you will get total assets. Total assets of ABC have 75 million dollars and XYZ also have 75 million dollars total assets. Now we are looking at current liabilities. So current liabilities are of 10 million dollars, ABC has 25 million dollars and XYZ has 25 million dollars. We have accounted for the long term debt of 50 million dollars, ABC has 10 million dollars and XYZ has 50 million dollars. So you can see that current liabilities are more than XYZ and the long term debt is more than ABC. To extract total liabilities, you have to collect the current liabilities with the long term debt. So you will get the value of total liabilities which is 60 million dollars for ABC, incorporation and 35 million dollars for XYZ company. So now if you look at the liabilities, ABC has more but the total assets of both were equal. Now we have looked at the shareholder activity. So it turned out to be 15 million dollars for ABC, incorporation and 40 million dollars. This means that the equity of XYZ is more than ABC. So now we have discussed the ratio with the help of this data. We calculate its value and we practice how it can be interpreted. Now for ABC incorporation, the current ratio which is current assets divided by current liabilities, that is 30 million dollars divided by 10 million dollars and that turned out to be 3. So the current ratio, I had told you, what it is telling us. It is telling us that the capacity we have to pay the liabilities, whether it is that capacity or not. So if this value is greater than 1, it means that the current assets we have are more than liabilities and we have the capacity to pay the debt and whatever liabilities you have to fulfill, you have sufficient available assets. To calculate the quick ratio, we did C plus MS plus AR divided by current liabilities and we had the value of I 30 dollars minus 10 million dollars and we divided it from current liabilities. So it turned out to be 2.0 as the value for the quick ratio. Then we looked at the equity ratio, which was the debt of 50. We had just seen 50 million dollars for ABC and the equity ratio was 15 million dollars. So it turned out to be the debt to equity ratio, 3.33. And the debt to assets, that is 50 million dollars divided by 75 million dollars and the ratio turned out to be 0.67 for ABC. With the same old data analysis, if it is for XYZ, then the current ratio is 0.4, the quick ratio is 0.3. The debt to equity ratio is 0.25 and the debt to asset ratio is 0.13. Now if we compare the two, we get to see that ABC incorporation is greater than the other company XYZ and its current ratio is 3. This means that it has a $1 liability to repay it. This means that it is a financially strong or stable company. Next is the quick ratio of ABC. It tells that it has adequate liquidity. If we exclude the inventories, then the assets of $2 million can be converted immediately in the form of ready-cash, which is to satisfy the current liability of $1. They have $2. And if we compare the same things to XYZ, then we get to see that the current ratio is 0.4. This means that it has inadequate liquidity. It has less money to pay $1. It has only $0.40. Just like the current ratio turned out to be 0.4 and I told you that it is smaller than 1, it has less money to fulfill its financial obligations. The quick ratio tells that the liquidity position is more dangerous. To repay the current liability of $1, it has only $0.20. With the help of different ratios, you can estimate the financial position, financial performance or financial health of any company. This is what are the basic advantages of calculating these different financial performance indicators or different ratios.