How to assess a company's ability to meet its obligations: a guide to current liquidity ratios

Liquidity indicators are analytical tools that allow investors and financial analysts to understand whether a given organization has sufficient resources to meet its short-term obligations. This is extremely important information for anyone looking to make informed investment decisions, as it shows the real financial strength of the enterprise.

Why is it worth knowing liquidity indicators?

Relying solely on the assessment of a company's ability to repay debts is too general an approach. A specific measurement is needed – and this is where liquidity ratios come into play. They allow quantifying the financial condition of a company in the short term, which is particularly important for creditors and investors seeking certainty. However, it should be noted that these measures alone are just a piece of a larger puzzle – a complete picture requires analysis in the context of the industry and historical performance.

Three Basic Ways to Measure Repayment Ability

Current liquidity ratio – starting point

The current liquidity ratio is the most commonly used measure in financial practice. It answers the question: how many current assets does a company have for each zloty of short-term liabilities?

Formula: current assets ÷ current liabilities

The higher the value of this indicator, the more comfortable the liquidity situation of the organization. However, this does not mean that higher = better all the time – sometimes a too high indicator may suggest ineffective capital management.

Quick Liquidity Indicator – a more stringent approach

This ratio narrows the analysis to only the most liquid assets, excluding inventories. Why? Because inventories are assets that can be difficult to quickly convert to cash. The quick liquidity ratio provides a more conservative assessment of actual repayment capabilities.

Formula: (cash + securities + receivables) ÷ current liabilities

Such a measurement is particularly useful in industries where inventory constitutes a significant part of current assets.

Cash Indicator – the most conservative perspective

For truly cautious analysts, there is also a metric based solely on cash in hand and in bank accounts. This is the most restrictive approach, which shows whether a company can meet its current obligations with cash alone.

Formula: available cash ÷ current liabilities

How to interpret the obtained values?

Understanding results is a key skill for anyone who wants to read financial statements. When the ratio is exactly 1, it indicates balance – assets exactly cover liabilities. A value below 1 is a warning sign, suggesting potential issues with current debt repayment. On the other hand, a value higher than 1 indicates a safe margin – the company has a reserve of resources.

However, the interpretation must always be contextual. One indicator is too little. It is necessary to compare it with industry standards, look at the historical trends of the given company, and analyze it in light of other financial ratios. A comprehensive assessment of the organization's condition only arises from the synthesis of many data and metrics.