Liquidity ratios

Liquidity Ratios

Financial metrics that measure a company’s ability to meet short-term obligations and convert assets into cash quickly, providing insight into short-term financial health and solvency.

For example, key liquidity ratios include:

• Current ratio (current assets ÷ current liabilities): A manufacturer with $2 million in current assets and $1 million in current liabilities would have a 2:1 ratio, generally considered healthy.
• Quick ratio (cash + marketable securities + accounts receivable ÷ current liabilities): If this same company had $800,000 in inventory, its quick ratio would be 1.2, still indicating adequate immediate liquidity.
• Cash ratio (cash + marketable securities ÷ current liabilities): If the company held $300,000 in cash and marketable securities, its cash ratio would be 0.3, suggesting potential challenges meeting immediate obligations with only the most liquid assets.

Liquidity ratios help stakeholders assess whether a company can meet upcoming financial obligations without disrupting operations. They provide early warning signs of potential financial distress and inform working capital management decisions. While higher ratios generally indicate stronger liquidity positions, excessive liquidity may suggest inefficient use of assets. Industry norms and company-specific factors significantly influence appropriate liquidity levels.