Liquidity Ratios for GM and Ford - Essay Example

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This essay discusses that the current ratio is a financial ratio used to determine the liquidity position of a company. The ratio is computed by dividing the current assets with the current liabilities to determine the proportion in which the current assets cover the current liabilities. …
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Liquidity Ratios for GM and Ford
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Download file to see previous pages From this paper it is clear that the higher the ratio the better it is for the company in theory but this does not hold truth in the real world situation. Despite the current ratio being used extensively in financial reporting, the ratio can be very misleading. In the real world situation, a high ratio does not necessary imply good liquidity position and a low current ratio does not necessary imply a bad liquidity position. This norm is contrary to the common belief of the current ratio as an adequate indicator of an entity’s liquidity. The ratio conceptualizes liquidation as the ability of a company’s current assets to offset its current liabilities. In the real sense, this does not occur as the investors’ measure a company, s liquidity as the going concern of the entity. 
This essay stresses that the first company has longer accounts receivables days and a low inventory turnover. The second company has a short accounts receivables period and a higher inventory turnover. The first company has a higher current ratio than the second company does but this does not imply that the company has a better liquidity position. This is because working capital but the cash do not pay the current obligations and since it does not converts its current easily into cash; the company is illiquid. The general concept and basis of the quick ratio is similar to that of the current ratio as it gives the users of the ratio an idia to determine the company's ability to offset its short-term obligations using its short-term assests.  

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