How to calculate liquidity ratios

Written by james collins
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How to calculate liquidity ratios
Banks prefer to lend money to companies with liquid operations. (liquid drops image by chrisharvey from Fotolia.com)

Liquidity, in the world of finance, is defined as the degree to which a company can pay off its short-term debts. Specifically, it refers to the ability to liquidate assets fast. Cash is the most liquid asset, but it may not provide a return commensurate with investment securities or real estate. As such, two of the most popular liquidity ratios are the current ratio and quick ratio. In general, the higher the ratio, the higher the liquidity.

Skill level:
Moderate

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Instructions

  1. 1

    Obtain the annual report for the company by downloading it from its website or requesting it from investor relations.

  2. 2

    Turn to the balance sheet and scroll to the line item called "current assets." These are the assets which can be liquidated within one year. For this example, the current assets are £65,000.

  3. 3

    Scroll down to "current liabilities." These are the liabilities which are due in less than one year. For this example, current liabilities are £32,500.

  4. 4

    Divide current assets by current liabilities for the current ratio. The calculation is £65,000 divided by £32,500, or 2.

  1. 1

    Research the "cash," "short-term investments," "current liabilities" and "accounts receivable" for the company in question. These are all line items on the balance sheet.

  2. 2

    Take the sum of cash, short-term investments and accounts receivable. For this example the sum of these line items is £52,000.

  3. 3

    Divide the sum by current liabilities for the quick ratio. The calculation is £52,000 divided by £32,500, or 1.6. The quick ratio is considered a more pure ratio as it does not include inventory in the numerator like the current ratio does.

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