Which ratio is considered a standard test of liquidity?

Which ratio is considered a standard test of liquidity?

• A. Quick Ratio
• B. Debt to Equity Ratio
• C. Current Ratio
• D. Return on Equity

Answer: (C)

The current ratio is widely recognized as a standard test of liquidity because it provides a direct measure of a company's ability to meet its short-term obligations with its short-term assets. This ratio is calculated by dividing current assets by current liabilities, giving insights into the company’s financial health and operational efficiency. Liquidity is essential for businesses, as it reflects the ability to pay off immediate debts and obligations without having to sell long-term assets. A current ratio of greater than one typically indicates that the company has more current assets than current liabilities, suggesting it can cover its short-term obligations comfortably. In contrast, the quick ratio, while also a measure of liquidity, excludes inventory from current assets, focusing strictly on more liquid assets. The debt to equity ratio primarily indicates leverage and risk rather than liquidity. Return on equity assesses profitability rather than a company’s short-term financial stability. Thus, while other ratios have their significance, the current ratio distinctly emphasizes the capacity to manage short-term liabilities, establishing it as the standard test of liquidity.

The current ratio is widely recognized as a standard test of liquidity because it provides a direct measure of a company's ability to meet its short-term obligations with its short-term assets. This ratio is calculated by dividing current assets by current liabilities, giving insights into the company’s financial health and operational efficiency.

Liquidity is essential for businesses, as it reflects the ability to pay off immediate debts and obligations without having to sell long-term assets. A current ratio of greater than one typically indicates that the company has more current assets than current liabilities, suggesting it can cover its short-term obligations comfortably.

In contrast, the quick ratio, while also a measure of liquidity, excludes inventory from current assets, focusing strictly on more liquid assets. The debt to equity ratio primarily indicates leverage and risk rather than liquidity. Return on equity assesses profitability rather than a company’s short-term financial stability. Thus, while other ratios have their significance, the current ratio distinctly emphasizes the capacity to manage short-term liabilities, establishing it as the standard test of liquidity.