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236. Liquidity - Current Ratios and Quick Ratios | Financial Literacy for Business Series
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Welcome to our Financial Literacy for Business Series!
In this episode, we dive into the concept of liquidity and explore two key ratios: the current ratio and the quick ratio.
What is Liquidity?
Liquidity refers to a company's ability to meet its short-term financial obligations using its most liquid assets. These are typically cash or assets that can be quickly converted to cash without significant loss of value. High liquidity means a company can easily cover its debts and operational expenses, whereas low liquidity suggests potential difficulties in meeting short-term liabilities, potentially affecting the company's financial stability.
Liquidity ratios are crucial for various stakeholders:
• Investors: Assess the company's financial health and ability to meet short-term obligations, influencing investment decisions.
• Creditors and Lenders: Evaluate the company's ability to repay short-term debt, aiding in credit and loan decisions.
• Management: Monitor and manage liquidity to ensure sufficient assets to cover liabilities and avoid cash flow issues.
• Analysts: Compare companies within the same industry and provide recommendations based on liquidity and financial stability.
Key Liquidity Ratios
1. Current Ratio: The current ratio measures a company's ability to pay off its short-term liabilities with its short-term assets. It's calculated as: Current Ratio = Current Assets / Current Liabilities. A current ratio between 1.5 and 3 is considered healthy.
2. Quick Ratio (Acid-Test Ratio): The quick ratio measures a company's ability to meet its short-term obligations with its most liquid assets, excluding inventories. It's calculated as: Quick Ratio = (Current Assets−Inventories) / Current Liabilities
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