What are the Liquidity Ratios in Financial Analysis

A financial ratio is a relative magnitude of two selected numerical values taken from an enterprise's financial statements. Often used in accounting, there are many standard ratios used to try to evaluate the overall financial condition of a corporation or other organization.

Financial ratios are useful tools that help business managers and investors analyse and compare financial relationships between the accounts on the firm's financial statements.

Liquidity Ratios:

Liquidity ratios are an important class of financial metrics used to determine a debtor's ability to pay off current debt obligations without raising external capital. Liquidity ratios measure a company's ability to pay debt obligations and its margin of safety through the calculation of metrics including the current ratio, quick ratio, and operating cash flow ratio.

  • Current Ratio (Working Capital Ratio)
    1. The current ratio measures a company's ability to pay off its current liabilities (payable within one year) with its current assets such as cash, accounts receivable and inventories. The higher the ratio, the better the company's liquidity position:
      Current Ratio = Current Assets / Current Liabilities
  • Quick Ratio
    1. The quick ratio measures a company's ability to meet its short-term obligations with its most liquid assets and therefore excludes inventories and pre-paid expenses from its current assets. It is also known as the "acid-test ratio"
      Quick Ratio = (Cash + marketable securities + receivables) / Current liabilities
  • Operating Cashflow Ratio
    1. The operating cash flow ratio is a measure of how well current liabilities are covered by the cash flows generated from a company's operations. The ratio can help gauge a company's liquidity in the short term.Using cash flow as opposed to net income is considered a cleaner or more accurate measure since earnings are more easily manipulated.
      Operating Cashflow Ratio = Cash Profit / Current liabilities