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Liquidity Ratios

Liquidity ratios measure the ability of a company to generate cash and to pay its obligations when they come due. The following are the most common liquidity ratios:

Working capital (current assets – current liabilities). This is really not a ratio, but a calculation. Calculating working capital will let an analyst know if there are more current assets than current liabilities, and how much more. It is better to have more current assets than current liabilities.

Current ratio (current assets/current liabilities). This ratio relates current assets to current liabilities. For this ratio, bigger is better.

Quick ratio (also called the acid-test ratio) [(cash + accounts receivable + marketable securities)/current liabilities]. Since not all current assets are created equal, the quick ratio omits some current assets. There is no exact way to compute the ratio, but the formulation given here is commonly used. Generally, inventory and prepaid expenses are omitted from the numerator. Bigger is better for this ratio as well.

Taken From : Accounting Demystified

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