The formula for the cash ratio is: cash ratio = (cash + cash equivalents) / current liabilities
2. The quick ratio
The quick ratio is the next level of a liquidity ratio. It adds a company's accounts receivable to its current assets since it should receive that cash over the next several weeks or months. The company should collect this money relatively quickly, hence the ratio's name.
The formula for quick ratio is: Quick ratio = (cash + cash equivalents + accounts receivable) / current liabilities
3. The current ratio
The current ratio (also sometimes called the working capital ratio) builds upon the quick ratio by adding inventory into the mix. A company's inventory is the finished products it could turn into cash in a relatively short period if it needed the funds.
The formula for the current ratio is: Current ratio = current assets (cash and equivalents + accounts receivable + inventory) / current liabilities
4. The operating cash flow ratio
The cash, quick, and current ratio calculate a company's liquidity based on inputs from its balance sheet. The operating cash flow ratio looks at liquidity through the lens of a company's cash flow statement. It examines whether a company generates enough operating cash flow to meet its financial obligations.
The formula for the operating cash flow ratio is: Operating cash flow / current liabilities
Why are liquidity ratios important?
Liquidity ratios provide a sense of a company's financial health. They show whether a company has adequate liquidity to meet its upcoming financial obligations or if it might face a liquidity crunch.
