28-06-2012, 05:12 PM
SHORT TERM SOLVENCY
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STATEMENT OF PROBLEM:-
SHORT TERM SOLVENCY
The term short term solvency refers to the short term liquidity of a company. The short term creditors of a company like suppliers of goods on credit, commercial banks providing short term loans are primarily interested in knowing the company’s ability to meet its short term obligation as and when these become due. These can be met only when there are sufficient liquid assets. So a firm must ensure that it does not suffer from lack of liquidity, which may affect the goodwill of the company. Even a high degree of liquidity is not good for a firm as it represents the excessive funds of the firm being tied up in current assets. Therefore it is very important and essential to have a proper balance in regards to the liquidity of the firm. Short term solvency of a company can be measured in two types of ratios i.e. liquidity ratio and efficiency ratio.
LIQUIDITY RATIO
Liquidity refers to the ability of a concern to meet its current obligations as and when these become due. The short term obligations are met by realizing amount from current, floating or circulating assets. The current assets should either be liquid or near liquidity. The sufficiency or insufficiency of current assets should be assessed by comparing them with short term liabilities. The liquidity of a firm can be calculated by the following ratios:
1. Current ratio.
2. Quick or Acid or Liquid ratio.
3. absolute liquid ratio or Cash ratio
ACTIVITY/EFFICIENCY RATIO
Activity ratio measures the efficiency or effectiveness with which a firm manages its resources or assets. These ratios are also called turn over ratio because these indicates the speed with which assets are converted or turned over into sales. Activity ratio includes stock turn over ratio, debtor turn over ratio, creditor turn over ratio and working capital turn over ratio depending upon the requirement. It is widely used to analysis the current assets movement of a concern. The efficiency of a company can be measured by the following ratios:
1. Stock turn over ratio.
2. Debtors turn over ratio.
3. Creditors turn over ratio.
4. Working capitals turn over ratio.
CONCEPT:-
The concept of the study is fully based on short term position of the concern. The short term solvency of a concern can known through various ratios. These ratios are calculated to comment upon the short term paying capacity of a concern or the firm’s ability to meet its current obligations and to see the efficiency with which the liquid resources have been employed by the firm. The following ratios will be used for analysis of short term solvency of a firm:-
1. Current ratio.
2. Quick ratio.
3. Absolute ratio.
4. Stock turn over ratio.
5. Debtors turn over ratio.
6. Creditors turn over ratio.
7. Working capitals turn over ratio.