Liquidity Ratios

Concept

Measuring Short-Term Ability to Pay

Liquidity ratios measure a company's ability to meet short-term obligations. The Current Ratio = Current Assets / Current Liabilities. A ratio above 1.0 means the company has more current assets than liabilities. The Quick Ratio (Acid-Test) = (Cash + Short-term Investments + A/R) / Current Liabilities — it excludes inventory and prepaid expenses for a stricter test.

Example

Calculating Ratios

Current Assets: $150,000 (Cash $30K, A/R $50K, Inventory $60K, Prepaids $10K) Current Liabilities: $100,000 Current Ratio = $150,000 / $100,000 = 1.5 Quick Ratio = ($30K + $50K) / $100,000 = 0.80 The current ratio looks healthy but the quick ratio reveals reliance on inventory.

Key Point

Working Capital

Working Capital = Current Assets – Current Liabilities. Positive working capital means the company can cover short-term debts. Negative working capital is a warning sign of potential liquidity problems.

Profitability Ratios

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