What does a liquidity ratio assess?

A liquidity ratio is designed to assess a company's ability to meet its short-term obligations using its most liquid assets. This measure is crucial for evaluating a business's financial health, particularly its capability to pay off current liabilities without raising external capital or selling long-term assets.

Liquidity ratios, such as the current ratio and quick ratio, provide insight into the company's working capital management and cash flow situation. A higher liquidity ratio indicates a stronger ability to cover short-term debts, suggesting that the company is well-positioned to handle immediate financial demands. Therefore, this ratio is essential for investors, creditors, and management to assess operational efficiency and risk in the context of short-term financial stability.