Liquidity Ratio Analysis Definition
The liquidity ratio is a financial metric used to assess a company’s ability to pay off its short-term debts. The higher the ratio, the more capable the company is of meeting its financial obligations.
There are a few different ways to calculate the liquidity ratio, but the most common is to divide current assets by current liabilities. This gives you a number that represents how many times over the company could pay off its debts if it had to liquidate all of its assets immediately.
A ratio of 1 means the company just has enough assets to cover its debts, while a ratio below 1 indicates that the company would be unable to pay off its debts if it had to liquidate immediately. A higher ratio is generally better, as it shows that the company has more cushion to cover unexpected expenses or emergencies.
Ideally, you want to see a liquidity ratio of 2 or higher, which means the company has twice as many assets as it does liabilities and is in good financial health. However, every industry is different, so you’ll need to compare a company’s liquidity ratio against others in its sector to get a more accurate picture.
