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FAQs
What is the meaning of liquidity ratio? ›
It's a ratio that tells one's ability to pay off its debt as and when they become due. In other words, we can say this ratio tells how quickly a company can convert its current assets into cash so that it can pay off its liability on a timely basis.
What's a good liquidity ratio? ›Generally, a good Liquidity Ratio should be above 1.0. This indicates the company has enough current assets to cover its short-term liabilities. A higher Liquidity Ratio (above 2.0) shows the company is in a stronger financial position and may have spare cash available for investments or other opportunities.
What does a liquidity ratio of 1.5 mean? ›A current ratio of 1.5 would indicate that the company has $1.50 of current assets for every $1 of current liabilities. For example, suppose a company's current assets consist of $50,000 in cash plus $100,000 in accounts receivable. Its current liabilities, meanwhile, consist of $100,000 in accounts payable.
What are the four liquidity ratios? ›Liquidity Ratio Formula
| Liquidity Ratios | Formula |
|---|---|
| Current Ratio | Current Assets / Current Liabilities |
| Quick Ratio | (Cash + Marketable securities + Accounts receivable) / Current liabilities |
| Cash Ratio | Cash and equivalent / Current liabilities |
| Net Working Capital Ratio | Current Assets – Current Liabilities |
The current ratio for Company ABC is 2.5, which means that it has 2.5 times its liabilities in assets and can currently meet its financial obligations Any current ratio over 2 is considered 'good' by most accounts.
What liquidity ratio is too high? ›Current ratio
If the ratio is higher, 4:1 it could mean that the firm is inefficient and has too much money tied up in stock. On the other hand, a lower ratio value of 1:1 would mean that it may not be able to meet its debts quickly. Ways of improving this is to: increase current assets.
A good current ratio is between 1.2 to 2, which means that the business has 2 times more current assets than liabilities to covers its debts. A current ratio below 1 means that the company doesn't have enough liquid assets to cover its short-term liabilities.
What is a 0.5 liquidity ratio? ›A quick ratio of 0.5 would mean that a company only has £0.50 in assets for every £1 it owes in short-term liabilities, meaning it would not have enough to meet its short-term liabilities.
What is a 2.1 liquidity ratio? ›A current ratio of 2:1 or higher is generally considered good, indicating that the company has sufficient current assets to meet its short-term obligations. However, a current ratio that is too high may also indicate that the company is not efficiently using its assets to generate profits.
How to read liquidity ratios? ›A ratio of less than 1 (e.g., 0.75) would imply that a company is not able to satisfy its current liabilities. A ratio greater than 1 (e.g., 2.0) would imply that a company is able to satisfy its current bills. In fact, a ratio of 2.0 means that a company can cover its current liabilities two times over.
How to solve liquidity ratio? ›
Types of liquidity ratios
- Current Ratio = Current Assets / Current Liabilities.
- Quick Ratio = (Cash + Accounts Receivable) / Current Liabilities.
- Cash Ratio = (Cash + Marketable Securities) / Current Liabilities.
- Net Working Capital = Current Assets – Current Liabilities.
Focus - Liquidity focuses on cash, assets that can quickly become cash, and short-term liabilities. Profitability focuses on profits in relation to revenue, assets, equity, and other inputs. Indications - Higher liquidity suggests greater short-term financial health.