How to Assess Liquidity?
Liquidity means the ability of a company to convert its assets into cash. Effectively managing liquidity is crucial for maintaining the financial health and stability of an organization. There are few ratios with the help of which we can assess the liquidity of an organisation. The ratios are as follows,
1. Current Ratio: The current ratio assesses the short-term solvency of the company. Current assets are those assets that can be converted into cash within a year and current liabilities are those liabilities that can be paid off within a year. The ideal current ratio is considered to be 2:1.
[Tex]Current~Ratio=\frac{Current~Liabilities}{Current~Assets}[/Tex]
2. Quick Ratio: It is also known as Liquid Asset or Acid Test Ratio. It focuses on the company’s ability to cover short-term obligations with its most liquid assets. The ideal quick ratio is considered to be 1:1.
[Tex]Liquid~Ratio=\frac{Liquid~Assets}{Current~Liabilities}[/Tex]
3. Working Capital: Working capital represents the amount of capital available to cover short-term obligations after subtracting short-term liabilities. Positive working capital indicates that the company has more current assets than current liabilities, which is favourable for liquidity.
[Tex]Working~Capital=Current~Assets-Current~Liabilities[/Tex]
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