Liquidity Ratio

Liquidity ratios are ratios that measure and give evaluative assistance into determining how well a company can meet or pay its short-term debt obligations. Liquidity ratios are an important indicator of a company's financial wellbeing.

Features

• Common liquidity ratios incorporate the quick ratio, current ratio, and days sales outstanding.
• Liquidity ratios determine a company's ability to cover short-term obligations and cash flows, while solvency ratios are worried about a longer-term ability to pay continuous debts.
• Liquidity ratios are an important class of financial metrics used to determine a debtor's ability to pay off current debt obligations without raising outer capital.

FAQ

What Happens If Ratios Show a Firm Is Not Liquid?

In this case, a liquidity crisis can emerge even at solid companies — assuming conditions emerge that make it challenging to meet short-term obligations, for example, repaying their loans and paying their employees or providers. One illustration of a sweeping liquidity crisis from recent history is the global credit crunch of 2007-09, where many companies found themselves unable to secure short-term financing to pay their immediate obligations.

Why Are There Several Liquidity Ratios?

Fundamentally, all liquidity ratios measure a firm's ability to cover short-term obligations by separating current assets by current liabilities (CL). The cash ratio takes a gander at just the cash available partitioned by CL, while the quick ratio includes cash equivalents (like money market holdings) as well as marketable securities and accounts receivable. The current ratio incorporates every current asset.

What Is liquidity and Why Is It Important for Firms?

Liquidity alludes to how effectively or proficiently cash can be gotten to pay bills and other short-term obligations. Assets that can be promptly sold, similar to stocks and bonds, are likewise viewed as liquid (despite the fact that cash is, of course, the most liquid asset of all). Organizations need sufficient liquidity close by to cover their bills and obligations so they can pay merchants, keep up with payroll, and keep their operations going every day of the week.

How Does Liquidity Differ From Solvency?

Liquidity alludes to the ability to cover short-term obligations. Solvency, then again, is a firm's ability to pay long-term obligations. For a firm, this will frequently incorporate having the option to repay interest and principal on debts (like bonds) or long-term leases.