Most conservative liquidity ratios

C

The cash ratio is the most conservative of the 3 liquidity ratios since it considers only cash and marketable securities relative to the current liabilities.

The most conservative of the following liquidity ratios is the "cash ratio."

The liquidity ratios are financial metrics used to evaluate a company's ability to meet its short-term obligations using its current assets. These ratios assess the company's liquidity position by measuring the availability of cash and near-cash assets to cover its immediate liabilities.

Let's examine each of the options:

A. Current Ratio: The current ratio is calculated by dividing current assets by current liabilities. It includes all current assets such as cash, accounts receivable, inventory, and prepaid expenses. While the current ratio provides a general indication of a company's liquidity, it includes assets that may not be readily convertible to cash or may have uncertain values. For example, inventory might be difficult to sell quickly or may be subject to price fluctuations. Hence, the current ratio is less conservative compared to other options.

B. Quick Ratio: The quick ratio, also known as the acid-test ratio, is calculated by dividing quick assets by current liabilities. Quick assets include cash, cash equivalents, marketable securities, and accounts receivable (net of any allowances for bad debts). The quick ratio excludes inventory and prepaid expenses, as these assets may not be easily converted into cash in the short term. By excluding inventory, the quick ratio provides a more conservative measure of a company's liquidity than the current ratio.

C. Cash Ratio: The cash ratio is calculated by dividing cash and cash equivalents by current liabilities. It considers only the most liquid assets available to meet short-term obligations. Cash and cash equivalents include physical cash, demand deposits, and highly liquid investments with maturities of three months or less. The cash ratio provides the most conservative measure of liquidity since it focuses solely on cash and cash equivalents, which are the most readily available assets to meet obligations.

D. Liquid Ratio: The term "liquid ratio" is not a commonly used liquidity ratio in financial analysis. It is possible that this option is a distractor or a term specific to this particular exam. Without further information or clarification, it is difficult to assess the specific characteristics of the liquid ratio. However, based on the commonly used liquidity ratios, the cash ratio would still be the most conservative option.

In summary, the cash ratio is considered the most conservative of the liquidity ratios mentioned. It focuses exclusively on cash and cash equivalents, providing a more stringent assessment of a company's ability to meet its short-term obligations compared to the other ratios.