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How to Easily Remember the Difference between Liquidity Ratios and Solvency Ratios - YouTube
Channel: LearnerInfinity
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Still confused on how to differentiate聽
liquidity ratios against solvency ratios?聽聽
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Well, don't worry. In this video I will show you聽
on how to easily remember the difference between聽聽
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liquidity ratios and solvency ratios. Some of聽
you might still confuse about the difference in聽聽
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definitions between liquidity ratios and solvency聽
ratios. For liquidity ratios, think of mnemonic聽聽
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LAST. L stands for liquidity. A is ability. S聽
is short. T is term. So liquidity ratio measures聽聽
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the ability to pay short-term obligations.聽
For solvency, we just shuffle the word LAST
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which results to the word SALT. S stands聽
for solvency. A ability. L stands for聽聽
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long. And T is term. So solvency ratio measures聽
the ability to pay long-term obligations.聽聽
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Just remember the pneumonic last salt. Imagine聽
you're about to cook your favorite meal聽聽
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then you realize that you only have the last聽
pinch of salt. Another way to easily differentiate聽聽
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between liquidity ratios and solvency聽
ratios is to use the mnemonic LS. This means聽聽
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liquidity is related to short term聽
obligations. Shuffle the two letters聽聽
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then you have SL. This means solvency聽
is related to long-term obligations.聽聽
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Very easy, right? Another difference between the聽
two groups of ratios is the formula. In liquidity聽聽
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ratios most of the ratios place liabilities as聽
the denominator specifically current liabilities.聽聽
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In solvency ratios most of the ratios聽
place liabilities as the numerator.聽聽
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Take note that I use the word most. This聽
is because some solvency ratios such as聽聽
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interest coverage and fixed charge coverage聽
have formulas that don't use total debt聽聽
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as either numerator or denominator. Take note聽
also that total debt has different definitions.聽聽
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Total debt can be interest-bearing short-term and聽
long-term debt. It can include only the long-term聽聽
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debt while some define it as all the liabilities.聽
So check the textbook used in classroom.聽聽
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Check also the official formulas used in聽
exams such as CPA, CMA and CFA. Another聽聽
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difference between the two groups of ratios聽
is the interpretation. In liquidity ratios,聽聽
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a higher ratio is generally better.聽
It indicates greater liquidity.聽聽
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It's the opposite situation with solvency ratios.聽
A lower ratio is generally better. It denotes聽聽
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lower financial risks and stronger solvency. Of聽
course the exceptions are the previously mentioned聽聽
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interest coverage and fixed charge coverage聽
where high ratio indicates stronger solvency.
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