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“One drawback of the current ratio is that inventory may include many items that are difficult to liquidate quickly and that have uncertain liquidation value. SO the quick ratio is an alternative measure of liquidity that does not include inventory in the current assets”.

(Paper3.6, BPP Professional Education, June 2007)

Quick Ratio “The quick ratio also known as the acid test ratio eliminates inventory from the currant assets. It provides the acid test of whether the company has sufficient liquid resources (receivables and cash) to settle its short term liabilities. Normal level for quick ratio ranges from 1:1 to 0.7:1”.

(Kaplan Financial, Paper F7 Study Text)

For Shell, liquidity ratio remained unchanged within the industry standards between 2006 and 2008 to stand at 0.9. This shows the company’s ability to pay short liabilities from most liquid resources i.e. receivables and cash not inventory.

(Appendix)

BP’s quick ratio showed a sorry picture and remains unchanged on 0.7 between 2006 and 2008, as it was standing at the danger level of 0.7 meaning that BP is not having enough liquid resources to pay off the liabilities due.

(Appendix)

d. Risk Ratios

Gearing: “Gearing is the relationship between the company’s fixed return capital and its equity capital. Gearing ratio indicates the degree of risk attached to the company and the sensitivity of earnings and dividends to change in profitability and activity level. High geared businesses uses large proportion of fixed return capital, so there are greater chances of insolvency and ultimately return to shareholders grow proportionately more if profits are growing. While low geared businesses provide scope to increase borrowings when potential profitable projects are available and can usually grow more easily”.

(Kaplan Financial, Paper F7 Study Text)

Gearing levels in (%) (2006-2008)

Shell maintained smooth profits and more suitable assets for security in order to make use of gearing successfully. Shell’s gearing level increased in 2008 due to more debts taken as compared to 2006 and 2007. Gearing was 23% in 2008 compared to 17% in 2007. The gearing ratio was 15% in 2006. The increase was due to rise in the total debt.

On the other hand, BP gearing level was also high standing between 36% to 28% with 36% in 2008 compare to 28% in 2006, while 2007 figure was 33%, which is higher than Shell.

High level of gearing means high risk to business, but this is compensated by a significant increase in profits and the returns to the shareholders. So Shell can borrow more easily in future.

Interest Cover “Company’s interest cover indicates the ability to pay interest out of profits generated. Low interest cover indicates to the shareholders that their dividends are at risk (because most profits are use to pay interest payments) and the company may have difficulty financing its debts if its profits fall”.

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