Which ratios measure financial liquidity and how are these ratios calculated?
The world of finance can feel like a black box. The industry is full of complicated-sounding ratios and grandeur terms. However, once you understand the core principles, learn how to calculate the ratios, and how to use ratios it becomes a lot less complicated. In this article, we will go over each ratio and discuss the following:
1. The definition of the ratio and why it’s important
2. How to calculate the ratio
3. How to find the right information in the balance sheet
Before we dive into the liquidity ratios, read the first article in the series if you need to brush up on exactly what financial liquidity means.
1. Current Ratio
The current ratio looks at a firm’s ability to pay off its short term financial obligations. These are all liabilities and debts that must be paid within a year. On the balance sheet, these can be found by looking at the Current Liabilities. This is made up of accounts payable, short-term debt, and others. Given that the current liabilities must be paid within a year, it’s natural then that we should compare this against assets that can be liquidated within a year to pay for them. The value of these assets can be found by looking at the Current Assets…
