Liquidity ratios measure a business’s ability to pay its short-term obligations—like bills, wages, and loan payments—using its current assets. In simple terms, they tell you how quickly a business can turn what it owns into cash to cover what it owes in the near future.

“Liquidity is about survival—can the business pay its bills right now?”

The current ratio is calculated using the formula: Current Ratio = Current Assets ÷ Current Liabilities. This ratio indicates how many times a business can cover its short-term debts using its short-term assets. A ratio above 1 means the business has more current assets than current liabilities, which generally suggests good short-term financial health. On the other hand, a ratio below 1 may be a red flag, indicating potential cash flow issues or a risk of not being able to meet upcoming obligations.

The quick ratio is calculated using the formula: Quick Ratio = (Current Assets – Inventory) ÷ Current Liabilities. Unlike the current ratio, this version excludes inventory and focuses only on the most liquid assets—such as cash, marketable securities, and accounts receivable. It provides a stricter measure of liquidity because inventory may not be quickly converted into cash when needed. This ratio is especially useful for businesses that hold large amounts of stock or sell slow-moving products.

Liquidity ratios help answer some of the most critical short-term financial questions a business faces. Can it pay salaries next month? Will it be able to cover upcoming bills without needing to borrow more money? Is it financially healthy in the short term? These ratios provide clear insights into a company’s ability to manage its immediate obligations. They are especially important to owners, investors, and lenders, as they want assurance that the business won’t suddenly face a cash crunch or be unable to meet its day-to-day expenses.

✅ Liquidity ratios measure short-term financial health