23 slides to introduce liquidity ratios for stock investors
TRANSCRIPT
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October 2016 www.inveyo.com | @inveyo
23 slides to introduce
LIQUIDITY RATIOSAND HOW YOU CAN USE THEM TO ANALYZE STOCKS
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To help you learn, download our Financial Ratios Calculator for Windows 10 at the Windows Store:
https://www.microsoft.com/en-us/store/p/inveyo-financial-ratios-calculator/9nblggh57ggr
First of all…why should I care about this?
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Understand A Stock Before You Buy It.Don’t rush into stocks…analyze them first.
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• Financial ratios help you gauge the financial performance of a company (i.e. stock).
• Isn’t it better to buy a stock when you understand the financial performance of the underlying company?
• Financial ratios will help you make better investment decisions.
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So What Is Liquidity?
A great definition from www.businessdirectory.com:
A measure of the extent to which a person or organization has cash to meet immediate and short-term obligations, or assets
that can be quickly converted to do this.
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the amount of money you haveIn simpler terms, it is
to pay your upcoming bills (usually within 12 months).
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Companies Have BillsSo where will the money come from to pay them?
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• Cash.• Investments (e.g. their own stock investments that
they can sell quickly for cash).• Accounts receivable (e.g. customers who owe the
company money).• Inventory (e.g. products that can be sold in the
near-term for cash).
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How Liquid Is A Company?Liquidity ratios to the rescue.
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• Liquidity ratios help us measure how liquid a company is.
• There are 3 very common liquidity ratios:– 1. Current Ratio (also known as the Liquidity Ratio).– 2. Cash Ratio– 3. Quick Ratio
1. Current Ratio =current assets
current liabilities
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2. Cash Ratio =cash + STI
current liabilities
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where STI stands for Short Term Investments.
3. Quick Ratio =cash + AR + STI
current liabilities
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where AR stands for Accounts Receivable and STI stands for Short Term Investments.
So, how do I calculatethese ratios……and where do I get the numbers from?
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the balance sheetThe numbers you need come from
of the company you’re interested in, and the balance sheet can be found in their annual report.
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Example: Walmartand their balance sheet from their 2016 annual report
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Example: Walmartand here’s the data we need highlighted in green.
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Current Ratio = $60,239/$64,619 = 0.93
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which means (in a sense) that Walmart has $0.93 of things that can be converted to money for every $1 of near-term
bills.
Cash Ratio = $8,705/$64,619 = 0.13
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which means (in another sense) that Walmart has $0.13 of cash available for every $1 of near-term bills.
Quick Ratio = ($8,705 + $5,624)/$64,619 = 0.22
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which means (in yet another sense) that Walmart has $0.22 of cash and accounts receivables available for every $1 of
near-term bills.
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Interpreting The NumbersWalmart only has $0.93 for every $1 of bills?
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• Ideally, the current ratio should be 1 or higher, and may be around 1.5 for healthy companies, but can vary depending on the company’s industry.
• Generally we want the cash and quick ratios to be as high as possible, since higher values mean the company is more liquid.
• So, how come Walmart doesn’t have enough assets to pay their short-term bills?
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Walmart’s Power Over BillsYou probably can’t do what they do.
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• Walmart has tremendous power over their suppliers, which means they don’t always pay for inventory when they receive it.
• This is why they only have $0.93 of current assets for every $1 current liabilities.
• This is common in the retail industry, and liquidity ratios are different across industries.
Want to learn moreabout financial ratios?
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Stay tuned!More to come…
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