What Is a Liquidity Ratio? (2024)

FAQs

What Is a Liquidity Ratio? ›

A ratio of 1 means that a company can exactly pay off all its current liabilities with its current assets. A ratio of less than 1 (e.g., 0.75) would imply that a company is not able to satisfy its current liabilities. A ratio greater than 1 (e.g., 2.0) would imply that a company is able to satisfy its current bills.

A good liquidity ratio is anything greater than 1. It indicates that the company is in good financial health and is less likely to face financial hardships. The higher ratio, the higher is the safety margin that the business possesses to meet its current liabilities.

Liquidity ratios are a measure of the ability of a company to pay off its short-term liabilities. Liquidity ratios determine how quickly a company can convert the assets and use them for meeting the dues that arise. The higher the ratio, the easier is the ability to clear the debts and avoid defaulting on payments.

Liquidity ratios are employed by analyst to determine the firm's ability to pay its short-term liabilities. The current ratio is the best-known measure of liquidity. The most conservative liquidity measure is the cash ratio.

For instance, a quick ratio of 1.5 indicates that a company has $1.50 of liquid assets available to cover each $1 of its current liabilities. While such numbers-based ratios offer insight into the viability and certain aspects of a business, they may not provide a complete picture of the overall health of the business.

Generally speaking, a good quick ratio is anything above 1 or 1:1. A ratio of 1:1 would mean the company has the same amount of liquid assets as current liabilities. A higher ratio indicates the company could pay off current liabilities several times over.

The current ratio for Company ABC is 2.5, which means that it has 2.5 times its liabilities in assets and can currently meet its financial obligations Any current ratio over 2 is considered 'good' by most accounts.

The three main liquidity ratios are the current, quick, and cash ratios. The current ratio is current assets divided by current liabilities. The quick ratio is current assets minus inventory divided by current liabilities. The cash ratio is cash plus marketable securities divided by current liabilities.

The most common Liquidity Ratio is the acid-test ratio. This measures a company's ability to pay off its short-term debts with liquid assets, such as cash equivalents or working capital.

Liquidity measures can be classified into four categories: (i) transaction cost measures that capture costs of trading financial assets and trading frictions in secondary markets; (ii) volume-based measures that distinguish liquid markets by the volume of transactions compared to the price variability, primarily to ...

How to get quick assets? ›

Quick assets = (cash + cash equivalents + short-term investments + accounts receivable ) / (current liabilities)

A low liquidity ratio, such as 0.5, indicates that a company does not have enough current assets to cover their current liabilities. If these current liabilities needed to be paid sooner than expected, the company would not be able to afford.

Lower returns: Since cash is largely a risk-free asset, investors don't get the “risk premium” that other investments, like mutual funds or GICs, may come with. Inflation risk: While cash has no capital risk, inflation can erode its purchasing power – meaning you wouldn't be able to buy as much with it in the future.

Generally, a good Liquidity Ratio should be above 1.0. This indicates the company has enough current assets to cover its short-term liabilities. A higher Liquidity Ratio (above 2.0) shows the company is in a stronger financial position and may have spare cash available for investments or other opportunities.

Generally, a Quick Ratio of 1.0 or greater is considered adequate to ensure a company's ability to pay its current obligations.

A ratio of 1 is better than a ratio of less than 1, but it isn't ideal. Creditors and investors like to see higher liquidity ratios, such as 2 or 3. The higher the ratio is, the more likely a company is able to pay its short-term bills.

Low current ratio: A ratio lower than 1.0 can result in a business having trouble paying short-term obligations. As such, it may make the business look like a bigger risk for lenders and investors.