Liquidity ratio is the class of financial metrics which is used for the determination of a company’s ability to repay its short term obligations. Usually, the higher value of this ratio indicates that a company has a large margin of safety in order to cover short term debts.
Explanation of Liquidity Ratio
Commonly, liquidity ratios include quick ratio, acid ratio, current ratio, and operating cash flow ratio. It is very important for the companies to convert short term assets into cash to cover debts. Mortgage originators and bankruptcy, analysts use the liquidity ratio frequently in order to determine the ability of a company to pay its short term liabilities. On the other hand, working capital plays a vital role in maintaining the solvency or liquidity of a company.
Liquidity ratio not only used for measuring the case of a business, but it used to measure that how a company can easily convert its assets into cash when it is required. Assets such as trading securities, inventories, and account receivables are relatively easy for many companies to be converted into cash to meet the short term liabilities.