101 Concepts for the Level I Exam
Concept 48: Liquidity and Solvency Ratios
Liquidity ratios measure a company’s ability to meet current liabilities. The higher the liquidity ratio, the more likely the firm will be able to meet its short term obligations.
- Current ratio – It is the most widely used measure of liquidity.
Current ratio = current assets / current liabilities
- Quick ratio – It is a more conservative measure of liquidity. It excludes inventories and less liquid assets from the numerator
- Cash ratio – It is the most conservative measure of liquidity. Even receivables are excluded from the numerator.
Solvency ratios measure a company’s ability to meet long-term obligations. A high ratio indicates high leverage and a high financial risk.
- Long term debt to equity ratio — It measures long term financing sources relative to total equity.
- Debt to equity ratio– It measures total debt relative to total equity.
- Total debt to assets ratio – It measures the extent to which assets are financed by liabilities.
- Financial leverage ratio – It measures total assets relative to total equity.