Liquidity ratios

Liquidity ratios are financial metrics that gauge whether a company can pay its short-term debts — those due within a year — out of assets it can readily convert to cash. They are calculated from the balance sheet and answer a simple question: if obligations came due soon, could the business cover them without raising new capital?

The two core measures are the current ratio and the quick ratio. The current ratio is current assets ÷ current liabilities: a company with $200,000 of current assets and $100,000 of current liabilities has a current ratio of 2.0, meaning $2 of near-term resources for every $1 owed. The quick ratio (also called the acid-test ratio) is stricter, excluding inventory from current assets because inventory can be slow to sell — (current assets − inventory) ÷ current liabilities.

Interpretation depends on context. A ratio comfortably above 1 signals a cushion, while a ratio below 1 warns that liabilities exceed liquid resources. But norms vary by industry — a supermarket turning inventory daily operates safely at ratios that would alarm analysts of an industrial manufacturer — so ratios are most meaningful compared against prior periods and industry peers.

Liquidity ratios appear throughout accounting and finance exams. The ACCA Financial Accounting (FA) exam tests calculating and interpreting the current and quick ratios as part of financial statement analysis, including explaining what a change in a ratio suggests about a company's working capital position.