Liquidity Ratios:

Liquidity Ratios: Types and Their Importance


Liquidity ratios measure a company’s ability to pay its short-term obligations. They indicate how well a company can convert its assets into ready cash to meet its obligations and are used to assess a company’s financial health. Liquidity ratios are important because they measure a company's ability to meet its short-term obligations.


Common types of liquidity ratios include the following:


1. Current Ratio: The current ratio measures the relationship between current assets and current liabilities. It is calculated by dividing current assets by current liabilities.

2. Quick Ratio: The quick ratio, also known as the acid test ratio, measures the relationship between liquid assets and current liabilities. It is calculated by dividing liquid assets by current liabilities.

3. Cash Ratio: The cash ratio measures the relationship between cash and current liabilities. It is calculated by dividing cash by current liabilities.

4. Accounts Receivable Turnover: The accounts receivable turnover measures the speed of collection of accounts receivable. It is calculated by dividing net sales by average accounts receivable.

5. Inventory Turnover: The inventory turnover measures the speed of the sale of inventory. It is calculated by dividing cost of goods sold by average inventory.

Understanding and using liquidity ratios can help businesses and investors assess the financial health of a company. They are important because they provide an indication of the company's ability to meet its short-term obligations. They can also be used to compare a company's liquidity to that of its competitors.


how to calculate these liquidity ratios

1. Current Ratio: Current Assets / Current Liabilities 

2. Quick Ratio: (Current Assets - Inventory) / Current Liabilities 

3. Cash Ratio: Cash / Current Liabilities 

4. Accounts Receivable Turnover: Net Sales / Average Accounts Receivable 

5. Inventory Turnover: Cost of Goods Sold / Average Inventory

calculate the liquidity ratio for a dummy resturant business


Let's assume the following figures for a dummy restaurant business:


Current Assets: $100,000

Current Liabilities: $50,000

Inventory: $20,000

Cash: $10,000

Net Sales: $200,000

Average Accounts Receivable: $10,000

Cost of Goods Sold: $150,000

Average Inventory: $25,000


1. Current Ratio: $100,000 / $50,000 = 2:1 

2. Quick Ratio: ($100,000 - $20,000) / $50,000 = 1.4:1 

3. Cash Ratio: $10,000 / $50,000 = 0.2:1 

4. Accounts Receivable Turnover: $200,000 / $10,000 = 20 times 

5. Inventory Turnover: $150,000 / $25,000 = 6 times

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