Liquidity ratios are a group of ratios used to measure the ability of a business operation to meets its current obligations. Liquidity ratios are similar to the initial medical tests a patient receives at a doctor’s visit. Doctors take blood pressure, temperature, and pulse rate. The doctor wants assurance that the primary indicators of health are good. Liquidity ratios are exactly the same. The user wants to know that the basic measurements of a business indicate good health today.
The cash ratio is a liquidity measurement tool designed to evaluate the immediate ability of an enterprise to pay its current liabilities. The cash ratio is all cash and cash equivalents divided by current liabilities. Sophisticated business users will rarely give credence to this particular ratio due to its inherent limitations.
Insolvency refers to the ability to pay bills in a timely manner. It does not mean bankruptcy but long-term insolvency is a underlying factor of bankruptcy. Many owners and/or managers of small business have no idea of how to determine if the company is insolvent or headed towards the inability to meet their day to day obligations.