What Is a Liquidity Ratio? (2024)

FAQs

What is the meaning of liquidity ratio? ›

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.

Common liquidity ratios include the quick ratio, current ratio, and days sales outstanding. Liquidity ratios determine a company's ability to cover short-term obligations and cash flows, while solvency ratios are concerned with a longer-term ability to pay ongoing debts.

A Liquidity Ratio of 1.5 means that a company has $1.50 in liquid assets for every $1 of its current liabilities, indicating that the company can cover its short-term obligations.

A good range for the current ratio to fall within is typically 1.5 to 3. If the current ratio is 3, that means the company has enough current assets to pay for its current liabilities threefold. If the ratio is less than 1, the company does not have enough current assets on hand to pay for its current liabilities.

A higher liquidity ratio means that your business has a more significant margin of safety with regard to your ability to pay off debt obligations.

Current ratio is the ratio of total current assets over total liabilities. The formula for current ratio is: Current ratio = Current assets / Current liabilities. A current ratio of 2.5 means that for every of liabilities there is $2.50 of current assets.

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. A ratio of less than 1 means the company faces a negative working capital and can be experiencing a liquidity crisis.

Coca-Cola Co has a current ratio of 1.04. It generally indicates good short-term financial strength. During the past 13 years, Coca-Cola Co's highest Current Ratio was 1.52.

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.

What is a bad liquidity ratio? ›

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.

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.

A quick ratio above one is considered ideal as this can indicate that a company can readily eliminate its current liabilities by utilizing its liquid assets if required. If a quick ratio is below one, then this might suggest that a company might struggle to pay off its liabilities in the short term.

Results. Indicates the number dollars of quick assets available to pay each dollar of current liabilities. Generally, a Quick Ratio of 1.0 or greater is considered adequate to ensure a company's ability to pay its current obligations.

To calculate this ratio, you'll want to divide your cash and cash equivalents by your net worth. If the resulting percentage is lower than 15%, it could mean that much of your wealth is locked into illiquid assets that may be hard to convert into cash.