What is liquidity ratio?
Definition of liquidity ratio
A liquidity ratio indicates whether a company’s current assets can pay off current debt obligations. There are two liquidity ratios that you can use to check your business: the current ratio and the quick ratio.
What are liquidity ratios?
The current ratio is a way of measuring whether a business has enough cash on hand to pay its debts either currently or in the near future. The formula for calculating the ratio is:
current ratio = current assets / current liabilities
A ratio of less than one suggests that the business is not in the best position to pay its debts.
There is also the quick ratio:
quick ratio = (current assets less stock) / current liabilities
Any stock the business holds for sale is omitted from the calculation. This makes it easier to tell whether there’s enough cash already in the business, and due in from customers, to pay the business’s debts if the stock can’t be sold (perhaps if it has been damaged, has perished or has become obsolete).
Got questions? Ask Emily!
FreeAgent's Chief Accountant Emily Coltman is available to answer your questions in the comments.