In this article, we'll examine the "dynamic current ratio" to assess a company's liquidity status instead of the static but commonly used current ratio. It is often calculated alongside the quick ratio and the cash ratio, to provide analysts with a more complete picture of the short-term liquidity of the company being analyzed. Although these ratios have their flaws, the dynamic current ratio has several advantages compared to the quick and cash ratios. Read on to learn more about how you can use this ratio when analyzing a prospective investment.
Dynamic Current Ratio
One way of measuring the liquidity of inventory is to use the inventory turnover ratio to calculate the approximate number of times that inventory turns over per year. One could say that the more times inventory turns over, the more often you exchange inventory for cash and, as such, the more liquid it is. The same applies to accounts receivable when calculating the accounts receivable turnover ratio. That is, the more often accounts receivable turns over, the more often you exchange accounts receivable for cash and the more you extend its nearness to cash, i.e. its level of liquidity. Both ratios are shown below:
|Inventory turnover ratio =||COGS / Average InventoryAccounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable|