what is liquidity ratio

A liquidity ratio is a financial metric used to determine a companys ability to pay off its short-term debt obligations without raising external capital. It measures the ability of a company to use its near cash or quick assets to extinguish or retire its current liabilities immediately. There are several types of liquidity ratios, including the quick ratio, current ratio, and cash ratio. The quick ratio, also known as the acid-test ratio, is a type of liquidity ratio that measures the ability of a company to use its near cash or quick assets to extinguish or retire its current liabilities immediately. It is defined as the ratio between quickly available or liquid assets and current liabilities. Quick assets are current assets that can presumably be quickly converted to cash at close to their book values. A normal liquid ratio is considered to be 1:1, and a company with a quick ratio of less than 1 cannot currently fully pay back its current liabilities. Liquidity ratios are important to investors and creditors to determine if a company can cover its short-term obligations, and a ratio of 1 is better than a ratio of less than 1, but it isnt ideal. Creditors and investors like to see higher liquidity ratios, such as 2 or 3. The higher the ratio is, the more likely a company is able to pay its short-term bills. A ratio of less than 1 means the company faces a negative working capital and can be experiencing a liquidity crisis.