Liquidity ratio is defined as to test on the solvency position for the payment of short term liabilities. Liquidity ratio is the relationship between current assets and current liabilities.
If the company is unable to maintain proper liquidity positions, the company fails to meet its current obligation timely and will result bad credit rating, loss of creditors’ confidence etc. On the other hand, a very high degree of liquidity is also not desirable because of:
· Pile up of stock and slow moving stock
· Unsatisfactory debt collection
· Idle cash balance
Therefore, there should neither be excessive nor inadequate liquidity. Two commonly used liquidity ratios are:
a) Current Ratio
b) Quick Ratio
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