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Which of the following provides the best description of the liquidity ratios? Current ratio is the strictest test for a firm's liquidity position. If Firm A has higher values of all liquidity ratios than Firm B, and both firms are in the similar industry, then Firm A is managing its liquidity better than Firm B.. The quick ratio regards inventory as part of the current assets because it's more liquid than other types of current assets. Cash ratio between 0 and 0.5 is considered a safe range for a firm's liquidity.

Which of the following provides the best description of the liquidity ratios? Current ratio is the strictest test for a firm's liquidity position. If Firm A has higher values of all liquidity ratios than Firm B, and both firms are in the similar industry, then Firm A is managing its liquidity better than Firm B.. The quick ratio regards inventory as part of the current assets because it's more liquid than other types of current assets. Cash ratio between 0 and 0.5 is considered a safe range for a firm's liquidity.

Essentials Of Investments
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
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### Understanding Liquidity Ratios **Question: Which of the following provides the best description of the liquidity ratios?** 1. **Current ratio is the strictest test for a firm’s liquidity position.** 2. **If Firm A has higher values of all liquidity ratios than Firm B, and both firms are in the similar industry, then Firm A is managing its liquidity better than Firm B.** 3. **The quick ratio regards inventory as part of the current assets because it’s more liquid than other types of current assets.** 4. **Cash ratio between 0 and 0.5 is considered a safe range for a firm’s liquidity.** In evaluating a firm's liquidity position, the following key ratios are commonly used: 1. **Current Ratio**: This measures a company's ability to pay short-term obligations with its current assets. Contrary to the statement in option 1, the current ratio is not the strictest test as it includes all current assets in its calculation, including inventory and other less liquid assets. 2. **Comparison of Liquidity Ratios**: Option 2 suggests that a higher liquidity ratio indicates better liquidity management when comparing firms within the same industry. This is generally a correct approach because it shows the firm’s ability to meet its short-term liabilities with its most liquid assets. 3. **Quick Ratio**: The quick ratio, also known as the acid-test ratio, excludes inventory from current assets in its calculation. This is because inventory is not considered as liquid as other current assets like accounts receivable and cash. Option 3 is incorrect as it inaccurately describes the quick ratio. 4. **Cash Ratio**: The cash ratio measures the extent to which a company can cover its short-term liabilities with cash and cash equivalents alone. A cash ratio between 0 and 0.5 is typically considered a safe range, which aligns with the statement in option 4. For educators, it’s crucial to emphasize the correct definitions and appropriate use of these ratios when evaluating and comparing firms' liquidity positions.
Transcribed Image Text:### Understanding Liquidity Ratios **Question: Which of the following provides the best description of the liquidity ratios?** 1. **Current ratio is the strictest test for a firm’s liquidity position.** 2. **If Firm A has higher values of all liquidity ratios than Firm B, and both firms are in the similar industry, then Firm A is managing its liquidity better than Firm B.** 3. **The quick ratio regards inventory as part of the current assets because it’s more liquid than other types of current assets.** 4. **Cash ratio between 0 and 0.5 is considered a safe range for a firm’s liquidity.** In evaluating a firm's liquidity position, the following key ratios are commonly used: 1. **Current Ratio**: This measures a company's ability to pay short-term obligations with its current assets. Contrary to the statement in option 1, the current ratio is not the strictest test as it includes all current assets in its calculation, including inventory and other less liquid assets. 2. **Comparison of Liquidity Ratios**: Option 2 suggests that a higher liquidity ratio indicates better liquidity management when comparing firms within the same industry. This is generally a correct approach because it shows the firm’s ability to meet its short-term liabilities with its most liquid assets. 3. **Quick Ratio**: The quick ratio, also known as the acid-test ratio, excludes inventory from current assets in its calculation. This is because inventory is not considered as liquid as other current assets like accounts receivable and cash. Option 3 is incorrect as it inaccurately describes the quick ratio. 4. **Cash Ratio**: The cash ratio measures the extent to which a company can cover its short-term liabilities with cash and cash equivalents alone. A cash ratio between 0 and 0.5 is typically considered a safe range, which aligns with the statement in option 4. For educators, it’s crucial to emphasize the correct definitions and appropriate use of these ratios when evaluating and comparing firms' liquidity positions.
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