Introduction to Liquidity Measures

What you will learn to do: Calculate ratios that indicate a company’s short-term debt-paying ability

Liquidity analysis looks at a company’s available cash and its ability to quickly convert other current assets into cash to meet short-term operating needs such as paying expenses and debts as they become due. Cash is the most liquid asset; other current assets such as accounts receivable and inventory may also generate cash in the near future.

Creditors and investors often use liquidity ratios to gauge how well a business is performing. Since creditors are primarily concerned with a company’s ability to repay its debts, they want to see if there is enough cash and equivalents available to meet the current portions of debt.

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The most common measures of liquidity are:

  • Working Capital
  • Current Ratio
  • Quick Ratio and Acid-Test Ratio
  • Cash Turnover Ratio

Working capital and the current and quick ratios evaluate a company’s ability to pay its current liabilities.

The cash turnover ratio is an indicator of the number of times cash is turned over in an accounting period and is most relevant for companies that don’t extend credit.