Investments, tenth edition

  Liquidity Ratios 

 Leverage is one measure of the safety of a firm’s debt. Debt ratios compare the firm’s 

indebtedness to broad measures of its assets, and coverage ratios compare various mea-

sures of earning power against the cash flow needed to satisfy debt obligations. But lever-

age is not the only determinant of financial prudence. You also want to know that a firm 

can lay its hands on cash either to pay its scheduled obligations or to meet unforeseen 

obligations.    Liquidity    is the ability to convert assets into cash at short notice. Liquidity is 

commonly measured using the current ratio, quick ratio, and cash ratio. 

    1.     Current  ratio:      Current assets/current liabilities. This ratio measures the ability of 

the firm to pay off its current liabilities by liquidating its current assets (i.e., turning 

them into cash). It indicates the firm’s ability to avoid insolvency in the short run. 

GI’s current ratio in 2011, for example, was (60  1  30  1  90)/(36  1  87.3)  5  1.46. 

In other years, it was