FINANCIAL SOUNDNESS AND STABILITY

Current ratio assumes that current assets could be turned cash immediately. However not all current assets can be readily converted into cash. The acid test ratio recognizes this limitation and excludes stocks and prepaid expenses on its computation because they might not be readily convertible into cash.

The formula is:-

$\text{Acid test ratio} = \frac{\text{Quick assets}}{\text{Current liabilities}}$

OR

$\frac{\text{Current assets} - \text{stock} - \text{prepaid expenses}}{\text{Current liabilities}}$

It measures the ability of a firm to service debt from operations. This ratio is computed as:

$\text{Interest coverage ratio} = \frac{\text{Profit before interest and tax}}{\text{Annual interest payment}}$

Gives an indication of the length of time it will take to repay borrowings out of profit of the business.

It is calculated as:

$\text{Debt repayment coverage ratio} = \frac{\text{Long term liabilities} + \text{Current liabilities}}{\text{Annual profit after interest and income tax}}$

This measures the ability of a company to make preferred dividend payments each year.

It is given as:

$\text{Preferred dividend coverage ratio} = \frac{\text{Net profit after interest and tax}}{\text{Annual preferred dividend}}$