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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 rati= current assets / current liabilities

     $$Current\ ratio=\ {{current\ assets}\over {current\ liabilities}}$$

  • Quick ratio – It is a more conservative measure of liquidity. It excludes inventories and less liquid assets from the numerator

     ]$$Quick\ ratio=\ {{cash+marketable\ securities+receivables}\over {current\ liabilities}}$$

  • Cash ratio – It is the most conservative measure of liquidity. Even receivables are excluded from the numerator.

     $$Cash\ ratio=\ {{cash+marketable\ securities}\over {current\ liabilities}}$$

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.

     $$Long\ term\ debt\ to\ equity=\ {{total\ long\ term\ debt}\over {total\ equity}}$$

  • Debt to equity ratio– It measures total debt relative to total equity.

     $$Debt\ to\ equity=\ {{total\ debt}\over {total\ equity}}$$

  • Total debt to assets ratio – It measures the extent to which assets are financed by liabilities.

     $$Debt\ to\ assets=\ {{total\ debt}\over {total\ assets}}$$

  • Financial leverage ratio – It measures total assets relative to total equity.

     $$Financial\ leverage\ ratio=\ {{total\ assets}\over {total\ equity}}$$