Study Sheet of Liquidity Ratios

Business Math Terms

  • An Asset is any 'thing' a business can own. Buildings, equipment, and vehicles are examples of assets that can be depreciated, while cash, bonds, and inventories are assets that are not depreciated.
  • Current Assets are most easily converted into cash in less than a year.
  • Current Liabilities are obligations that must be met within a year.
  • Inventory is the amount of finished product available for sale. It can be found on the balance sheet in the current assets section.
  • Liquid Assets are the most current of current assets. Liquid assets can be immediately spent. For example, cash and checks are liquid assets; inventory is a current asset but is not liquid. (Unless it's beer!)
  • Liquidity is a company's ability to meet current obligations using liquid assets.

Current Ratio

  • The Current Ratio measures a company's ability to meet short-term obligations (under a year) by using current assets
  • Given the current assets and current liabilities from a company's balance sheet:

    Current Ratio = (Current Assets) / (Current Liabilities)

  • Generally, the higher the ratio, the stronger the liquidity position of the company and the more easily it can meet its obligations.

Quick Ratio

  • The Quick Ratio, or Acid Test Ratio, measures a company's ability to meet current liabilities without additional sales of inventory.
  • For any business with inventory, the Quick Ratio will be lower than the Current Ratio.
  • Given the current assets, inventories, and current liabilities from a company's balance sheet:

    Quick Ratio = (Current Assets – Inventories) / (Current Liabilities)

  • Like the current ratio, the higher the ratio, the stronger the liquidity position of the company.