Not logged in, please login to view portfolio!

Blog Stocks


Sarmaaya Desk
Sarmaaya Content Team

Key Takeaways

  1. Liquidity refers to how easily an asset can be converted into cash
  2. Most common ratios used to calculate liquidity are the current ratio, quick ratio and operating cash flow ratio
  3. it is important to understand an assets liquidity level before investing in it because it could take time to convert back to cash.

What is Liquidity?

In financial terms, liquidity refers to how easily an asset can be converted into cash. Assets like property, equipment and plants are very difficult to convert into cash, hence they are not very liquid. However, assets like stocks and bonds can be converted into cash within days, hence they are very liquid.


In financial markets, liquidity implies how quickly an investment can be sold without adversely affecting its price. The more liquid the investment is, more quickly can it be sold. In financial analysis, liquidity measures how quickly and effectively a business can meet its short term financial obligations such as paying off their liabilities. The cash that the company generates, by liquidating its assets and fulfilling its financial obligation is used by the company to either expand the business or pay its shareholders via dividends, is also referred to as cash flows.

Understanding Liquidity

The most common ratios used to calculate and measure a company’s liquidity are as follows:


  • Current Ratio

This is also known as the working capital ratio. The current ratio is calculated by dividing the company’s current assets by the current liabilities. ‘Current’ itself refers to short term assets and liabilities that can be used and paid off in a time span of less than a year. A company should ideally have a current ratio greater than 1, which would imply that the company has more current assets than their liabilities. For competitive analytical purposes, comparison of ratios should take place between companies operating within the same industry for accurate representation.


  • Quick Ratio

This is also known as the acid test ratio. The quick ratio is almost the same as the current ratio, except that it does not include inventory in its calculations. This is because inventory is not as liquid and is converted to cash with difficulty. Like the current ratio, a value greater than 1 implies good liquidity. However, this is still subjected to the industry’s average and should only be analysed in comparison to it.


  • Operating Cashflow Ratio

This ratio measures how effectively the cash flow generated from the business operations cover the company’s current liabilities. The operating cash flow ratio is calculated by dividing operating cash flow by the company’s current liabilities. Higher the number, better is the company’s ability to cover current liabilities. This is an indication of the company’s financial health.

Components used in the calculations of the above-mentioned ratios are found in a company’s balance sheet where items are usually listed from the most liquid (cash) to least liquid (property, plant and equipment).

From an investor’s perspective, it is important to understand an asset’s liquidity level before investing in it because it could take time to convert back to cash.


Related articles

My Watchlist

Not logged in, please login to view watchlist!

If you are someone who is keen on investments but does not have the time to research, identify stock market patterns, and keep track of stocks, forex, mutual funds, cryptocurrencies and other commodities like Gold and silver, then Sarmaaya is your meeting place, the crossroads where you can find everything you need to make the best decisions in the trading market. Based on unbiased, accurate and free information.


abcData (Pvt) Limited (Sarmaaya) is a Pakistan Stock Exchange (PSX) authorized data redistributor. Sarmaaya & CS Solutions (Pvt.) Limited (CS) do not guarantee the timeliness, accurateness, or completeness of any data or information on the website. Sarmaaya & CS makes no warranties, express or implied, as to Sarmaaya & CS or any data or values relating thereto or results to be obtained therefrom, and expressly disclaims all warranties of merchantability and fitness for a particular purpose with respect thereto. To the maximum extent allowed by law, Sarmaaya & CS, its licensors, and their respective employees, contractors, agents, suppliers and vendors shall have no liability or responsibility whatsoever for any injury or damages – whether direct, indirect, consequential, incidental, punitive or otherwise – arising in connection with Sarmaaya & CS or any data or values relating thereto – whether arising from their negligence or otherwise. Nothing in the website shall constitute or be construed as an offering of financial instruments or as investment advice or investment recommendations (i.e., recommendations as to whether or not to “buy”, “sell”, “hold”, or to enter or not to enter into any other transaction involving any specific interest or interests) by Sarmaaya & CS or a recommendation as to an investment or other strategy by Sarmaaya & CS. Data and other information available via the website should not be considered as information sufficient upon which to base an investment decision.