Current Assets − Current Liabilities
Any ratio used in evaluating a firm’s ability to pay its short-term debts with current assets is a liquidity ratio. Liquidity ratios are of particular interest to those extending short-term credit to the firm. The higher the ratio, the greater the assurance that short-term creditors can be paid.
Liquidity Ratios → Measure short-term ability to pay maturing obligations and meet unexpected needs for cash
The ratios that are commonly used to measure a firm’s liquidity are the liquidity ratio, the quick ratio, the cash ratio and the cash-flow-from-operations ratio:
- Current ratio – Measures a firm’s ability to pay its current debts out of total current assets:
Current Assets ÷ Current Liabilities
- Quick ratio – Tests a firm’s short-term debt-paying ability through the use of only its most liquid (“quick”) assets:
(Cash, Cash Equivalents + Receivables) ÷ Current Liabilities
- Cash ratio – The most conservative of the liquidity ratios as it considers only actual cash and cash equivalent balances as available for paying off current liabilities:
(Cash + Cash Equivalents) ÷ Current Liabilities