What do liquidity ratios measure?

Liquidity ratios are financial metrics used to assess a company's ability to meet its short-term obligations, such as paying off current liabilities with its most liquid assets. They provide insight into a company’s operational efficiency and short-term financial health. A commonly used liquidity ratio is the current ratio, which compares current assets to current liabilities, indicating how well a company can cover its short-term debts.

By focusing on this capacity to satisfy immediate financial commitments, liquidity ratios are essential tools for creditors, investors, and management to evaluate risk and make informed decisions about the company's financial stability. Understanding liquidity is crucial, as a business that cannot meet its short-term obligations might face solvency issues, leading to a loss of confidence from stakeholders.