Question

What does the liquidity of a company represent? Name a liquidity ratio and how it is calculated

Answer 1

Liquidity of a company represents the company's ability to pay its short term obligations when due. It shows whether a company has sufficient current or liquid assets available to pay off its short term liabilities, when they will fall due.

One of the liquidity ratio is current ratio. It is calculated by the following formula:

Current ratio = Current assets / Current liabilities

where, current assets are the assets that are expected to be converted into cash or realized within next 1 year or operating cycle and current liabilities are the liabilities or obligations that are expected to be paid or settled within 1 year or operating cycle.