342 Accounting: Business Reporting for Decision Making
argued that the cash flow ratio is a better measure of liquidity than the current ratio, because it uses cash
flows generated over a whole reporting period rather than the current assets at a particular point in time.
The ratio is calculated as follows:
Net cash flows from operating activities
=x times
Current liabilitiesAnalysis of liquidity: JB Hi-Fi Ltd
JB Hi-Fi Ltd’s current ratio, quick ratio and cash flow ratio (liquidity) for 2015 and 2014 are presented
in figure 8.10.
JB Hi-Fi Ltd had $1.64 of current assets for every $1 of current liabilities in 2014. This decreased to
$1.62 of current assets for every $1 of current liabilities in 2015. As JB Hi-Fi Ltd has a relatively short
activity cycle, the company can operate with lower levels of liquidity. Given that JB Hi-Fi Ltd has a
large investment in inventories, the quick ratio should be significantly lower than the current ratio. The
quick ratio is 0.34 times and 0.36 times in 2014 and 2015 respectively. This suggests that JB Hi-Fi Ltd
had approximately $0.36 of current assets excluding inventory for every dollar of current liabilities. For
a retail operation, this is not unusual. In 2015, JB Hi-Fi Ltd had $0.47 of net operating cash flows for
every $1 of current liabilities. This significantly increased from $0.12 of net operating cash flows for
every $1 of current liabilities in 2014, suggesting that the company has capacity to meet its current obli-
gations from its net operating activities cash flows.
2015 2014Current ratio($616 898
$380 3361.62times
==$578 147
$352 1931.64times
==Quick ratio$616 898 $478 871
$380 3360.36times
−−
==
$578 147 $458 625
$352 1930.34times
−−
==Cash flow ratio (liquidity)$179 896
$380 3360.47times
==
$41 326
$352 1930.12times
==FIGU R E 8 .10 Analysis of liquidity of JB Hi-Fi LtdVALUE TO BUSINESS• An entity’s liquidity is the ability of the entity to meet its short-term obligations. Liquidity ratios focus
on relating current assets and cash availability to current liabilities.
• The current ratio and quick ratio are two measures of an entity’s liquidity. The ratios indicate the
dollar value of the entity’s current asset relative to the entity’s dollar value of current liabilities.
• Low liquidity ratios can reflect liquidity problems. High liquidity ratios are not desirable either, as they
indicate excess investments in unproductive current assets.