# Liquidity Ratios: Definitions, Formula, Calculation, Examples, Acid-Test Ratio, Quick Ratio, Current Ratio, Cash Ratio

## What are Liquidity Ratios?

Liquidity ratios are crucial financial metrics that help measure a company’s ability to pay off its short-term obligations using its current assets. The capacity of a company to stay liquid in the long-term is vital for its long-term success. Therefore, liquidity ratios help users measure if a company has enough current assets to cover its current liabilities.

Therefore, two components contribute to a company’s liquidity. Firstly, current assets are short-term assets that companies use in their daily operations. The higher a company’s current assets are, the more margin they have to cover their short-term obligations. On the other hand, current liabilities represent those short-term obligations. The lower these are, the better it is for a company’s liquidity.

There is no formula for liquidity ratio on its own. However, there are various types of liquidity ratios that users may use.

## What are the different types of Liquidity Ratios?

There are three prevalent liquidity ratios commonly used by investors. These include the current, quick, and cash ratios.

### The Current Ratio

The current ratio is the most straightforward liquidity ratio. It compares a company’s current assets with its current liabilities. It can help measure a company’s ability to pay off its current liabilities with its current assets. The higher the ratio is, the better the company’s liquidity position will be.

Usually, a current ratio of 2:1 or higher is considered best for companies. However, a lower number may also be acceptable depending on the industry in which a company operates. The formula for the current ratio is as follows.

Current Ratio = Current Assets / Current Liabilities

### The Quick Ratio

The quick ratio, also known as the acid test ratio, measures a company’s ability to meet its short-term obligations. However, it only considers the most liquid assets from the total current assets of a company. Therefore, the ratio does not consider a company’s inventories when measuring its liquidity position.

The higher a company’s quick ratio is, the better it is. Usually, a quick ratio of 1:1 or higher is considered best. However, for some companies, a lower quick ratio may be acceptable depending on the industry in which they operate. The formula for quick ratio is as follows.

Quick Ratio = (Current Assets – Inventory) / Current Liabilities

### The Cash Ratio

A company’s cash ratio even further classifies its current assets. This ratio only considers a company’s cash and marketable securities balances in meeting its short-term obligations. It is because cash and marketable securities are a company’s most liquid assets most readily available to pay short-term commitments.

As with other liquidity ratios, the higher the cash ratio is, the better it is. Usually, a cash ratio of 0.5:1 is considered favourable. However, it may also be lower for some industries. The formula for the cash ratio is as follows.

Cash Ratio = (Cash + Marketable Securities) / Current Liabilities

## What is the importance of Liquidity Ratios?

There are various reasons why liquidity ratios are crucial. Firstly, it helps users determine a company’s ability to pay its current liabilities. It can also help gauge a company’s creditworthiness. Investors may also use liquidity ratios for making decisions regarding their investments in companies.

## Conclusion

Liquidity ratios consider a company’s ability to pay its short-term obligations using its current assets. There are various liquidity ratios that companies may use. Among these, the most prominent ones include the current, quick, and cash ratios. Each of these considers several aspects of a company’s liquidity position.

## Further questions

Have an answer to the questions below? Post it here or in the forum

Views
Question
416
views
1108
views
413
views
LATEST NEWS
dynaCERT Expands Global Reach with Additional Shipments of HydraGEN™ Technology to South American Mines; Secures New Orders from Mexico and Australia

TORONTO — dynaCERT Inc. (TSX: DYA) (OTC: DYFSF) (FRA: DMJ) (“dynaCERT” or the “Company”) is pleased to announce the September 2024 shipment of its proprietary HydraGEN™ Technology to three major open-pit mines located in Brazil and Peru, South America. This latest shipment, totalling 119 HydraGEN™…

LATEST NEWS
TRREB: GTA Housing Market Becoming More Affordable

TORONTO, Sept. 05, 2024 (GLOBE NEWSWIRE) — Greater Toronto Area (GTA) home sales were down on a year-over-year basis in August 2024. New listings were up slightly over the same period. While the region’s housing market remained well-supplied in August, average home prices only edged…

LATEST NEWS
SCENTRE GROUP ANNOUNCES UPSIZE AND EARLY RESULTS OF TENDER OFFER
LATEST NEWS
Italy approves new rules to put beach concessions up for bidding by 2027

ROME (AP) — Italy approved new rules late Wednesday to put lucrative concessions for beach clubs up for bidding by June 2027, responding to pressing demands from the EU to open up the sector to new players. Under the new legislation by the right-wing government…

LATEST NEWS
MUSIC BROKERS: 25 Years of Success and Expansion in the Music Industry

MILAN, Sept. 05, 2024 (GLOBE NEWSWIRE) — MUSIC BROKERS celebrates its 25th anniversary, marking a significant milestone in the global music industry. Since its founding in Buenos Aires in 1997 by Federico Scialabba and Julian Cohen, the company has experienced exponential growth, revolutionizing the sector…