Liquidity Ratios

Every organization has some level of cash requirement for keeping its operations functional. Companies that are able to meet its cash requirement from a source with minimum cost, would maximize value for shareholders. Hence, the level of cash and liquidity of assets are very crucial to the survival of any organization. Liquidity is how easily an asset can be converted into cash.

Liquidity ratios give an idea about company’s ability to convert its assets into cash and pay its current liabilities with that cash whenever required. In simple language, they indicate the company’s ability to pay its short-term obligations whenever they are payable. Liquidity ratios focus on short-term survival of the company, while solvency focuses on long-term survival.



Current Ratio

It is found by dividing current assets by current liabilities. It shows whether current assets are enough to cover the current liabilities.

Current Ratio

=    Current assets          

Current liabilities

Quick Ratio/ Acid Test Ratio

It is similar to the current ratio. However, in current assets, illiquid assets like inventory are not considered. Inventory can only be liquidated when there are buyers for the same. In the economic downturn or emergency situations, it will be difficult to sell inventory.

Quick Ratio

=     Quick Current Assets

Quick Current liabilities

Cash Ratio

This ratio only includes cash and cash equivalents in the numerators. Cash and cash equivalents include cash and marketable securities.

Cash Ratio =   Total Cash and Cash Equivalents

               Current liabilities

Defensive Interval Ratio

It can be found by dividing liquid assets with estimated daily cash requirement. The daily cash requirement can be estimated from the past patterns of cash requirements. This ratio gives an idea whether liquid assets are enough to cover the daily cash requirements.

Defensive Interval Ratio

=                  Liquid Assets

Estimated Daily Cash Requirements


Liquidity ratios are very useful for analyzing liquidity position of the company. These ratios are used externally as well as internally for analysis. Analysts compare the liquidity ratios of one firm to another firm or the industry for comparative analysis. They are very useful to short-term creditors or lenders. Creditors have lent some amount to the company and they would want to know whether the company will be able to pay that back in time or not. Also, they are used internally by the company itself to compare its liquidity position with the previous year. It gives an idea about changes in liquidity position of the company.

All the comparative analysis will less reliable if companies are of different industry, location or size. It should be used to compare companies of same nature.


Last updated on : October 30th, 2017
What’s your view on this? Share it in comments below.

Leave a Reply

Loan to Value Ratio
  • How to Analyze and Improve Debt to Total Asset Ratio?
    How to Analyze and Improve Debt to …
  • Piggybank Surrounded In Coins Showing European Savings
    Cash Ratio
  • Limitations of Ratio Analysis
    Limitations of Ratio Analysis
  • How to Analyze and Improve Debtors Turnover Ratio / Collection Period?
    How to Analyze and Improve Debtors Turnover …
  • Subscribe to Blog via Email

    Enter your email address to subscribe to this blog and receive notifications of new posts by email.

    Join 122 other subscribers

    Recent Posts

    Find us on Facebook

    Related pages

    how to calculate degree of operating leveragehow to invest in debenturesactivity based budgeting advantagesfinance lease in cash flow statementcapital budgeting process stepsstages in budgeting processdividend growth model excelformula for discounted cash flowwhat is the formula for waccdividend irrelevanceleased equipment balance sheetdefine gdrhorizontal merger and vertical mergerroe rocediluted earnings per share equationlc transactioncompany waccirredeemable debtaverage inventory perioddistinguish between operating income and net incomedebt management ratio formulawhat does credit and debit mean in accountingsimple rate of return formulauses of profitability ratioswhat is the difference between shareholders and stockholderssignificance of profitability ratiosdscr rationhow to find profitability ratiooperating lease accounting lessordcf financialdcf intrinsic valueasset management ratio analysisequation for net profit marginwhat is cash flow and fund flowreceivables turnover analysisissue of debentures as collateral securitytotal assets turnoverconvertible debentures financial poststock velocity formulacompute weighted average cost of capitalusance lc payable at sightmoneychimp present value calculatoris notes payable a debit or creditexamples of conglomerate mergersbenefits of payback periodmodigliani and miller theoryconvertible debenture definitionmeaning of irredeemablehedge investopediaborrowing capacity ratiofinancial leverage investopediaquick ratio analysis interpretationadvantages and disadvantages of international tradeoperating lease vs finance leaseexample of ratio analysis financial statementfinancial breakeven pointinterpretation of gross profit ratioirr methoddefine tangible assetslimitation of abc analysisadvantages and disadvantages of debtpurpose of managerial accountingadvantages and disadvantages of breakeven analysisdifference between equity shares and debenturescalculate cost of equity using capmwhat does dr and cr mean in accountingbep pointhedging finance definitionpp&e turnoverwaccspbitrecording notes payableexpense vs capital expenditurethe normal balance of a capital account is a debit