Appendix B: Analyzing the Financial Statement Items

The financials can be overwhelming for investors. But by using ratio analysis, it is possible to make better sense of things. Here’s a look.

Liquidity Ratios

Liquidity ratios show the ability of a company to pay its debts. The most common liquidity ratio is the current ratio, which is calculated as follows:

Current ratio = Current assets/Current liabilities

As a general rule, you want a company that has a current ratio of 2:1 or higher. There may be exceptions, which makes it important to look at the current ratios of other companies in the industry.

The next liquidity ratio is the quick ratio or acid-test ratio. This uses essentially the same formula as the current ratio, except that inventories ...

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