The critical liquidity ratio as an indicator of solvency.

In order for production and other activities to be continuous, each enterprise must be solvent and liquid. As you know, liquidity implies the ability of a property to transform into a monetary form. However, in the context under consideration, the liquidity of an enterprise means its ability to pay on time in full and on its obligations in full. Obviously, the greatest interest is the firm's ability to repay its most urgent debts. It is equally obvious that for this purpose the organization should have enough liquid assets. Evaluation of this sufficiency is carried out using a special group of indicators - liquidity ratios. These include the critical liquidity ratio, total and absolute liquidity.

The most common indicator is precisely the name - the total coverage. He describes the adequacy of the company's liquid assets to cover its most urgent obligations. Like all liquidity indicators, this coefficient is calculated as a ratio. To calculate the coefficient, it is necessary to divide the current assets of the firm by the amount of its short-term liabilities. It should be noted that the normative values for the liquidity indicators are established, in particular, this coefficient should be more than 1, but less than 2. The lower limit determines the sufficiency of the property to cover debts, and the upper limit - the efficiency of using this property. More than twofold excess of the aggregate amount of current assets over time commitments indicates inefficiency of their use. If you exclude the amount of formed reserves from the calculation, you can determine the critical (fast) liquidity ratio.

The meaning of inventory exclusion is that, on the one hand, they are the least liquid component of current assets, and on the other hand, when realized, only half of the cost is often obtained. Thus, the critical liquidity ratio shows the adequacy of the liquidity of the enterprise to cover debts in the event of recovery of the entire amount of receivables. It becomes clear from the specifics of the calculation that this coefficient can not be greater than the one considered earlier, and its lower limit is also set at level 1 and requires liquidity. When calculating this coefficient, some adjustments may be necessary, which will allow only liquid assets to be taken into account. The matter is that part of the excluded stocks can appear more liquid, than included in the calculation of accounts receivable or financial investments. Mostly this applies to that part of the finished product, which is sold on a prepayment basis. The cost of this part of the inventory should be included in the calculation. As for the amounts of doubtful receivables, it is necessary to exclude it from the calculation in order not to overestimate the ratio. In addition, you should not take into account in the calculation of illiquid financial investments. The critical liquidity ratio thus determined will be much more accurate and close to the real situation.

If, on the other hand, only absolutely liquid assets are left in the numerator of the indicator, that is, money and property that is recognized as their equivalents, the result will be the value of the absolute liquidity indicator. It describes the proportion of liabilities that can be repaid instantly.

These coefficients must necessarily be analyzed. The easiest way is to study their change in dynamics, revealing the trends. For example, if the critical liquidity ratio for a certain period has decreased from 1.5 to 0.9, then this clearly makes it possible to judge the deterioration of the financial condition of the enterprise. It is required to make managerial decisions aimed at normalizing the situation.