**CHECK 6: Assets â€“ Liquidity ratio**

Liquidity answers the question: will this company run into trouble in the short term? Can the company pay its short-term debts? It can only do so if it has enough current assets and cash.

You determine the liquidity ratio as follows:

**Liquidity = Current assets / Current liabilities**

By dividing the current assets by the short-term debts (debts payable within 1 year) you obtain a percentage. This percentage is called the liquidity ratio. Most authors apply the rule that good liquidity starts with a ratio of 1 or higher. In other words: if the result of the higher formula is 1 or higher, you have a good ratio.

The reason behind the formula is that a healthy company has more current assets than current liabilities. After all, the current assets must enable the company to pay its debts that fall due in the short term. If there are too few current assets to meet short-term obligations, the company must find those resources elsewhere.