Legal Definitions - liquidity ratio

A liquidity ratio is a financial metric that measures the ability of a person or entity to pay off their current debts as they come due. It is calculated by dividing the amount of cash or liquid assets by the current liabilities.

Let's say a company has $100,000 in cash and short-term investments and $50,000 in current liabilities. The liquidity ratio would be:

Liquidity Ratio = ($100,000 / $50,000) = 2

This means that the company has twice as many liquid assets as it does current liabilities, indicating that it has a strong ability to pay off its debts in the short term.

Another example could be an individual who has $5,000 in a savings account and $2,000 in credit card debt. The liquidity ratio would be:

Liquidity Ratio = ($5,000 / $2,000) = 2.5

This means that the individual has 2.5 times more liquid assets than current liabilities, indicating that they have a good ability to pay off their debts in the short term.