What is a liquidity ratio?

A liquidity ratio is a type of financial ratio used to determine a company’s ability to pay its short-term debt obligations. The metric helps determine if a company can use its current, or liquid, assets to cover its current liabilities. Three liquidity ratios are commonly used – the current ratio, quick ratio, and cash ratio.

What are the different types of liquidity ratios used in financial analysis?

There are three primary types of liquidity ratios used in financial analysis: Cash Ratio – measuring cash and near-cash assets (the purest of ‘liquid assets’ ) against total current liabilities. Quick Ratio – uses cash, near-cash and receivables against current liabilities i.e. inventories are excluded.

How effective is liquidity ratio analysis?

Liquidity ratio analysis is less effective for comparing businesses of different sizes in different geographical locations. With liquidity ratios, current liabilities are most often compared to liquid assets to evaluate the ability to cover short-term debts and obligations in case of an emergency.