What is Liquidity Ratios Analysis and its types – Liquidity Ratios are ratios that measure a company’s ability to meet its short-term debt obligations till its due date.
The Liquidity Ratio measures the ability of a company to pay off short-term obligations when due. Basically, this Liquidity Ratio is the result of the distribution of cash and other current assets with short-term loans and current liabilities.
This ratio shows how many times short-term debt obligations can be covered by cash and other current assets. If the value is more than 1, it means that the short-term liabilities can be fully covered.
In general, the higher the liquidity ratio, the higher the safety margin owned by the company to fulfill its current liability. A liquidity ratio greater than 1 indicates that the company in question has a sound financial condition and is unlikely to experience financial difficulties.
Types of Liquidity Ratios
Several types of liquidity ratios that are commonly used to measure a company’s ability to meet short-term obligations when due are the current ratio (asset ratio), liquid ratio (quick ratio acid test), and Cash Ratio (Cash Ratio).
Current Ratio is a measure of financial balance sheet performance against company liquidity. The current ratio shows the company’s ability to meet short-term debt obligations. This Current Ratio measures whether the company has sufficient resources to pay off its debt for the next 12 months. Current Ratio is calculated by dividing current assets with current liabilities.
Current Ratio Formula
Current Ratio = Current Assets / Current Debt
Quick ratio (Quick Ratio or Acid Test Ratio)
Quick Ratio or also known as Acid Test Ratio is a measure of a company’s ability to meet its short obligations by using the most liquid assets or assets that approach cash (fast assets).
Fast assets include current assets that may be quickly converted into cash close to the book value. This Quick Ratio is seen as a sign of a company’s financial strength or weakness because it can provide information about the company’s short-term liquidity. This Quick Ratio can tell creditors how much the company’s short-term debt that can be fulfilled by selling all liquid assets in the shortest amount of time.
Quick Ratio formula
Quick Ratio = (Current Assets – Inventory) / Current Debt
Cash Ratio or Cash Ratio Cash Ratio is a ratio between total cash (cash) and cash equivalents of companies with current liabilities. This ratio is to determine whether the company can meet its short-term obligations. This Cash Ratio is generally a more conservative view of the company’s ability to cover its liabilities from other liquidity ratios because other assets and accounts receivable are not included in the calculation of this cash ratio.
Cash Ratio Formula
Cash Ratio = (Cash + Cash Equivalents) / Current Debt