What is a liquidity ratio in finance?

A liquidity ratio is a financial metric used to measure a company’s ability to cover its short-term liabilities with its short-term assets. The most common liquidity ratios are the current ratio and the quick ratio. The current ratio is calculated by dividing a company’s current assets by its current liabilities, indicating whether it can pay its short-term debts with its available assets. The quick ratio is a more stringent measure, excluding inventory from current assets, to assess a company’s ability to meet short-term obligations without relying on the sale of inventory. Liquidity ratios are important for assessing a company’s financial health and its ability to manage cash flow.