Two liquidity ratios
Liquidity ratios determine a company’s ability to meet its short-term obligations. The liquidity position of a company can be measured by using two main liquidity ratios:
- Current Ratio – Also known as the short-term solvency ratio or working capital ratio. It is calculated by dividing current assets by current liabilities
- Quick Ratio – Also known as liquid ratio or acid test ratio. It determines the liquidity position of a firm and is a more stringent measure of liquidity than the current ratio. This ratio is calculated by dividing liquid assets by current liabilities
Liquid assets = Total current assets-stock-prepaid expenses.
The above chart shows that Penn National Gaming, Inc.’s (PENN) current ratio improved to 1.4x and its quick ratio improved to 1.0x in 2013. In 2012, these ratios were 1.0x and 0.6x, respectively. These increases are attributable to a significant reduction in current liabilities, mostly short-term debt.
Meanwhile, as of June 30, 2014, PENN’s current ratio and quick ratio dropped to 1.3x and 0.8x, respectively. A major increase in accounts payable that increased current liabilities was to blame.
The above chart shows that PENN’s liquidity is better than Pinnacle Entertainment, Inc’s (PNK) and Boyd Gaming Corporation’s (BYD) for meeting short-term obligations. However, PENN’s liquidity is weaker than Caesars Entertainment Corp’s (CZR), which has the highest liquidity ratios of its peers.
Investors seeking diversified exposure to these companies could consider an ETF such as the Consumer Discretionary Select Sector SPDR Fund (XLY).
To learn why PENN makes an attractive investment, read the next part in this series.