Finance Basics
By Compounding Quality
5 Liquidity
Ratios
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Finance Basics
By Compounding Quality
Liquidity Ratio 1: Current Ratio
What does it measure?
The Current Ratio shows if a company can pay its short-term
debts with its short-term assets.
It tells you if the company has enough resources to cover
what it owes soon.
Formula
Current Ratio = Current Assets ÷ Current Liabilities
Example:
Current Assets = $200 million
Current Liabilities = $100 million
➡️Current Ratio = 2.0
This means the company has $2 in assets for every $1 it owes
in the short term.
How to interpret it?
✅ Between 1.5 and 2 = Healthy
⚠️ Below 1 = Can’t cover short-term debts
📘 Very high ratio (over 3) = Assets might not be used
efficiently
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Finance Basics
By Compounding Quality
Liquidity Ratio 2: Quick Ratio (Acid-Test Ratio)
What does it measure?
The Quick Ratio is like the Current Ratio but more strict.
It excludes inventory from assets, showing if a company can
pay debts quickly without selling inventory.
Formula
Quick Ratio = (Current Assets - Inventory) ÷ Current
Liabilities
Example:
Current Assets = $200 million
Inventory = $50 million
Current Liabilities = $100 million
➡️ Quick Ratio = (200 - 50) ÷ 100 = 1.5
This means the company has $1.50 of quick assets for every $1
owed.
How to interpret it?
✅ 1 or more = Strong liquidity
⚠️Below 1 = Might struggle without selling inventory
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Finance Basics
By Compounding Quality
Liquidity Ratio 3: Cash Ratio
What does it measure?
The Cash Ratio shows if a company can pay short-term debts
using only cash and cash equivalents.
Formula
Cash Ratio = (Cash + Cash Equivalents) ÷ Current Liabilities
Example:
Cash + Equivalents = $40 million
Current Liabilities = $100 million
➡️Cash Ratio = 0.4
This means the company has 40 cents in cash for every $1
owed.
How to interpret it?
📘 0.2 – 0.5 = Normal range
✅ Above 1 = Very safe, but maybe too conservative
⚠️Below 0.2 = Risky
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Finance Basics
By Compounding Quality
Liquidity Ratio 4: Operating Cash Flow Ratio
What does it measure?
This ratio shows if a company’s operating cash flow can cover
short-term debts.
Formula
Operating Cash Flow Ratio = Operating Cash Flow ÷ Current
Liabilities
Example:
Operating Cash Flow = $60 million
Current Liabilities = $100 million
➡️Ratio = 0.6
This means the company can cover 60% of short-term debts
with its yearly cash flow.
How to interpret it?
✅ Above 0.5 = Healthy
⚠️Below 0.3 = Watch out
@QCompounding
Finance Basics
By Compounding Quality
Liquidity Ratio 5: Working Capital
What does it measure?
The Working Capital Ratio shows the difference between
current assets and current liabilities.
It tells if the company has money left after paying its short-
term obligations.
Formula
Working Capital = Current Assets - Current Liabilities
Example:
Current Assets = $200 million
Current Liabilities = $150 million
➡️Working Capital = $50 million
This means the company has $50 million extra after paying
debts.
How to interpret it?
✅ Positive working capital = Good liquidity
⚠️Negative working capital = Liquidity problems
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Pieter Slegers
Compounding Quality
@QCompounding