Principles of Managerial Finance, 15th Edition

3.3 Liquidity Ratios

1. LG3

The liquidity of a firm reflects its ability to satisfy its short-term obligations as they come due. Generally speaking, a firm with greater liquidity will have an easier time paying its bills and is less likely to become insolvent. Because a common precursor to financial distress and bankruptcy is low or declining liquidity, these ratios can provide early warning signs that a company has cash flow problems that could cause the business to fail. Clearly, the ability of a firm to pay its bills is desirable, so having enough liquidity for day-to-day operations is important. However, liquid assets, like cash held at banks and marketable securities, do not earn a particularly high rate of return, so shareholders will ...