Inaccounting,liquidity (oraccounting liquidity) is a measure of the ability of adebtor to pay theirdebts as and when theyfall due. It is usually expressed as aratio or apercentage of currentliabilities. Liquidity is the ability to pay short-term obligations.
Thecurrent ratio is the simplest measure and calculated by dividing the total current assets by the total current liabilities. A value of over 100% is normal in a non-banking corporation. However, some current assets are more difficult to sell at full value in a hurry.
Thequick ratio is calculated by deducting inventories and prepayments from current assets and then dividing by current liabilities, giving a measure of the ability to meet current liabilities from assets that can be readily sold. A better way for a trading corporation to meet liabilities is from cash flows, rather than through asset sales, so;
The operating cash flow ratio can be calculated by dividing theoperating cash flow bycurrent liabilities. This indicates the ability to service current debt from current income, rather than through asset sales.
TheCrisis Liquidity Ratio (CLR), defined as (Current Assets – Receivables) / Current Liabilities, is used in crisis conditions to reflect situations where inventories may be more liquid than receivables. It was proposed by Bulgarian economist Petar P. Petrov and has been applied in liquidity studies of the Bulgarian automotive sector.[3]
For different industries and differing legal systems the use of differing ratios and results would be appropriate. For instance, in a country with a legal system that gives a slow or uncertain result a higher level of liquidity would be appropriate to cover the uncertainty related to the valuation of assets. Amanufacturer with stable cash flows may find a lower quick ratio more appropriate than an Internet-based start-up corporation.
Liquidity is a prime concern in abanking environment and a shortage of liquidity has often been a trigger for bank failures. Holdingassets in a highly liquid form tends to reduce theincome from that asset (cash, for example, is the most liquid asset of all but pays no interest) so banks will try to reduce liquid assets as far as possible. However, a bank without sufficient liquidity to meet the demands of theirdepositors risks experiencing abank run. The result is that most banks now try toforecast their liquidity requirements and maintain emergency standbycredit lines at other banks.Banking regulators also view liquidity as a major concern.
