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# Liquidity Ratio

## Definition

A financial metric that is used to measure a company’s ability to repay its short term debt obligations is called a liquidity ratio. The three most common liquidity ratios include the current, quick, and the cash ratio.

### Calculation

Current Ratio = Current Assets / Current Liabilities

Quick Ratio = (Cash + Marketable Securities + Accounts Receivable) / Current Liabilities

Cash Ratio = (Cash + Marketable Securities) / Current Liabilities

### Explanation

Of the financial ratios that utilize the balance sheet, the cash ratio is the most rigorous test of a company’s ability to satisfy short term debt. While the current ratio allows for all current assets in its calculation, the cash ratio limits the liquid assets to cash and marketable securities.

Generally, a cash ratio value that approaches 1.0 is considered satisfactory. With a ratio greater than 1.0, the company can satisfy current liabilities using just their cash and marketable securities and does not have to rely on the collection or payment of accounts receivable.

Liquidity ratios allow analysts, investors and creditors to quickly identify if a company may have trouble meeting its debt coming due in the next twelve months. When drawing conclusions about the relative performance of a company, benchmark comparisons should be made with competitors in the same industry.

### Example

Company A’s balance sheet indicates cash and cash equivalents of \$2,219,000, short term investments of \$1,461,000, and current liabilities of \$5,441,000. The cash ratio of Company A would be:

= (\$2,219,000 + \$1,461,000) / \$5,441,000 = \$3,680,000 / \$5,441,000, or 0.68