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Liquidity ratios

Liquidity ratios - the main purpose of these ratios is to show company’s abilities to meet its obligations and to pay its liabilities using different types of assets. Current ratio, quick ratio and cash ratio shows how company is able to pay its short term liabilities using different forms of short term assets.

When calculating current ratio, all short term assets are used, so this ratio is not very strict and can omit some problems in the company. Stricter ratio is quick ratio, which deducts inventories from the assets. Inventories are deducted because not always they are so liquid and on demand. The strictest ratio is cash ratio, which takes only cash money held in the company to cover its liabilities. Higher ratios show better company’s position in paying its obligations and higher liquidity of it. Other liquidity ratio is working capital, which is calculated by deducting current liabilities from current assets. Higher working capital is also showing higher liquidity of the company.

Liquidity ratios are important for the investors, because they can show how safe and how fast refundable their investments can be. Investors should also check if the liquidity is not mainly based on borrowed funds and if the company has any problems with borrowing, collecting money from its customers, paying for suppliers, or in managing its inventories.