Liquidity ratios are calculated to determine the short-term solvency of a business, i.e. the ability of the business to pay back its current dues. Liquidity means easy conversion of assets into cash without any significant loss and delay. Short-term creditors are interested in ascertaining liquidity ratios for timely payment of their debts.
Liquidity ratio includes:
Current Ratio: It explains the relationship between current assets and current liabilities. It is calculated as:
Current Ratio = \(\frac {\textit{Current Assets}}{\textit{Current Liabilities}} \)
Liquid Ratio or Quick Ratio: It explains the relationship between liquid assets and current liabilities. It indicates whether a firm has sufficient funds to pay its current liabilities immediately. It is calculated as:
Liquid Ratio = \(\frac {\textit{Liquid Asset}}{\textit{Current Liabilities}} \)
Liquids Assets = Current Assets – Stock – Prepaid Expenses
