## How to assess a company's financial strength through its liquidity ratios

When analyzing a potential investment, one of the first signals to review is whether the company can meet its short-term commitments. Liquidity ratios are exactly that: tools that reveal an organization’s ability to honor its immediate debts and maintain its operations smoothly. For investors, these indicators are essential because they anticipate possible financial difficulties before they escalate into a crisis.

### The three indicators that every investor should know

There are three main methods to measure how liquidity ratio is calculated in an organization, each with a different approach depending on the level of conservatism the analyst seeks.

**The current ratio: the most accessible indicator**

This is the starting point. Compare total current assets against current liabilities, showing how many units of assets the company has for each unit of short-term debt. The equation is simple:

_Current ratio = current assets ÷ current liabilities_

If the result is greater than one, the organization is in a comfortable position. A value equal to one means exact balance. Less than one indicates potential problems.

**The quick ratio: the most demanding test**

Also known as the Acid Test, this ratio is more restrictive. It excludes inventory from the calculation because stocks do not always convert to cash quickly. The formula is:

_Quick ratio = (cash + marketable securities + accounts receivable) ÷ current liabilities_

This indicator is preferred by investors who want a more realistic view of the immediate liquidity available.

**The cash ratio: the most cautious view**

For those who prefer absolute certainty, this ratio only considers the available cash:

_Cash ratio = cash on hand ÷ current liabilities_

It is the most conservative and, although it may seem very restrictive, it offers the clearest perspective on what can really be deployed to meet obligations.

### Practical interpretation of the results

A ratio greater than one is generally positive, indicating that assets exceed liabilities. However, this number should not be interpreted in isolation. The industry, the economic cycle, and the company's historical data provide critical context.

The ideal is to use these three ratios together, complementing them with other financial indicators, to build a comprehensive assessment of the economic health and stability of any organization before making investment decisions.