Chapter 12
Using Accounting Information
364
Liquidity Analysis
Liquidity
refers to the ability of a company to convert current assets into cash. This is important
because paying off liabilities, purchasing assets, and paying for business expenses are generally
done using cash.The more liquid a company is, the easier it is to cover obligations such as accounts
payable and loan payments.There are several ways to measure liquidity detailed in this section.
Working Capital
Working capital is a measure of liquidity. It can be quickly calculated and easily understood. The
formula for working capital is shown below.
Working Capital = Current Assets – Current Liabilities
Working capital is a dollar figure, not a ratio, so it is difficult to say how much working capital is
enough. A positive working capital indicates that the company has enough liquid assets to pay off
its upcoming debts.The working capital of Second Cup is calculated in Figure 12.13 for 2013 and
2014.
2014
2013
Current Assets
$16,430
$11,402
Current Liabilities
$23,684
$11,061
Working Capital
$(7,254)
$341
_______________
Figure 12.13
The working capital has gone from positive to negative which is an indication of poor liquidity.
The company may have to sell a long-term asset or raise cash through other means to pay off its
current liabilities.
Current Ratio
The current ratio is a useful ratio for determining the company’s ability to repay its upcoming debts
and obligations.The current ratio is calculated as shown below.
=
Current Assets
Current Ratio
Current Liabilities
