Liquidity or short-term solvency ratios

💧 Liquidity (Short-Term Solvency) Ratios

✅ Definition:

Liquidity ratios measure a business’s ability to pay off its short-term debts using its current or liquid assets. These are crucial for understanding the company’s short-term financial health.

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📊 Key Liquidity Ratios:

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1️⃣ Current Ratio

🧮 Formula:

Current Ratio = Current Assets / Current Liabilities

🔍 Purpose:

Shows whether the company has enough current assets to cover its current liabilities (due within one year).

📋 Example:

If a company has ₹2,00,000 in current assets and ₹1,00,000 in current liabilities:

Current Ratio = 2,00,000 / 1,00,000 = 2.0

✔️ A current ratio of 2.0 means the company has ₹2 in assets for every ₹1 in liabilities.

📌 Ideal Range: Typically between 1.5 and 2.5, but it varies by industry.

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2️⃣ Quick Ratio (Acid-Test Ratio)

🧮 Formula:

Quick Ratio = (Current Assets – Inventory – Prepaid Expenses) / Current Liabilities

OR

Quick Ratio = Quick Assets / Current Liabilities

🔍 Purpose:

A stricter test of liquidity — shows if the company can meet short-term obligations without relying on selling inventory.

📋 Example:

• Current Assets: ₹2,00,000
• Inventory: ₹50,000
• Current Liabilities: ₹1,00,000

Quick Ratio = (2,00,000 – 50,000) / 1,00,000 = 1.5

✔️ A quick ratio of 1.5 is considered healthy.

📌 Ideal: 1.0 or above (depends on industry)

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3️⃣ Cash Ratio

🧮 Formula:

Cash Ratio = (Cash + Cash Equivalents) / Current Liabilities

🔍 Purpose:

The most conservative liquidity ratio — measures whether a company can pay off current liabilities only with cash and near-cash items.

📋 Example:

• Cash + Cash Equivalents = ₹80,000
• Current Liabilities = ₹1,00,000

Cash Ratio = 80,000 / 1,00,000 = 0.8

✔️ Means the company can cover 80% of its short-term debts with cash.

📌 Ideal: 0.5 to 1.0 is considered reasonable, but again, this varies by industry.

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🧠 Why These Ratios Matter:

• 📦 Help determine operational efficiency
• 💸 Show if the company can pay salaries, rent, and vendors
• 📉 Prevent short-term liquidity crises or bankruptcy
• 💬 Important for creditors, banks, and suppliers

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🧾 Quick Summary Table:

Ratio	Formula	Ideal Value	Measures
Current Ratio	Current Assets / Current Liabilities	1.5 – 2.5	Overall short-term solvency
Quick Ratio	(Current Assets – Inventory) / Current Liabilities	1.0+	Liquidity without relying on inventory
Cash Ratio	(Cash + Equivalents) / Current Liabilities	0.5 – 1.0	Most conservative liquidity measure

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