Ratios in respect of Liquidity Risk Management

Liquidity risk is the risk that an organization will not have enough cash or other liquid assets to meet its financial obligations as they come due. There are a number of ratios that organizations can use to measure their liquidity risk.

Some of the most common liquidity ratios include:

  • Current ratio: The current ratio is a measure of an organization’s ability to meet its short-term obligations. It is calculated by dividing current assets by current liabilities. A current ratio of 2 or more is considered to be healthy.
  • Quick ratio: The quick ratio is a more conservative measure of an organization’s ability to meet its short-term obligations. It is calculated by dividing quick assets by current liabilities. Quick assets are current assets that can be converted to cash quickly, such as cash, marketable securities, and accounts receivable. A quick ratio of 1 or more is considered to be healthy.
  • Cash ratio: The cash ratio is the most conservative measure of an organization’s ability to meet its short-term obligations. It is calculated by dividing cash and cash equivalents by current liabilities. A cash ratio of 1 or more is considered to be healthy.

MCQs on Ratios in respect of Liquidity Risk Management

  1. Which of the following is NOT a liquidity ratio?
    • Current ratio
    • Quick ratio
    • Cash ratio
    • Debt to equity ratio
    • The correct answer is debt to equity ratio. Debt to equity ratio is a debt ratio, not a liquidity ratio. It measures the extent to which an organization is financed by debt.
  2. Which of the following liquidity ratios is the most conservative?
    • Current ratio
    • Quick ratio
    • Cash ratio
    • Debt to equity ratio
    • The correct answer is cash ratio. The cash ratio is the most conservative liquidity ratio because it only considers assets that can be converted to cash quickly.
  3. Which of the following liquidity ratios is the most commonly used?
    • Current ratio
    • Quick ratio
    • Cash ratio
    • Debt to equity ratio
    • The correct answer is current ratio. The current ratio is the most commonly used liquidity ratio because it is a simple and easy-to-calculate measure of an organization’s liquidity position.

Conclusion

Liquidity ratios are a valuable tool for organizations to measure their liquidity risk. By tracking their liquidity ratios over time, organizations can identify any potential liquidity problems and take steps to mitigate those risks.