# Short Term Solvency (Liquidity) Ratios (Definition)

As the name suggests short term solvency ratios or commonly known as liquidity ratios are used to obtain

information about the

**company’s ability to meet its short term obligations**as and when fall due. In other words ability to settle obligations that fall due within a period of 12 months, therefore these ratios focus on current assets and liabilities of the company.

## Types of Short Term Solvency (Liquidity) Ratios

To check the ability of the company of meeting its short term obligations following ratios are used.

- Current Ratio
- Quick Ratio or Acid Test Ratio
- Cash Ratio

Use this brain map after studying all five ratios to understand the logic.

Following pages will explain the listed above ratios using the written below method:

**FORMULA ***(short term solvency ratios)*

*(short term solvency ratios)*

First question comes in mind is HOW TO CALCULATE THE PARTICULAR RATIO? I will write down the most common formula used for calculating a ratio along with alternative, if any.

EXAMPLE(short term solvency ratios)With example I will calculate the ratio using the formula given above.

PLEASE NOTE THAT,in examples I will use data fromHYPOTHETICAL FINANCIAL STATEMENTSso that you can calculate ratios from real financial statements in you practical life.(as given here)

## MEASUREMENT UNIT *(short term solvency ratios)*

In which unit the ratio is measured i.e. in currency unit (dollars), percentages, days or whatever.

## INTERPRETATION *(short term solvency ratios)*

After calculating the ratio, the next logical question that comes in mind is WHAT DOES THIS RATIO MEAN? So I will teach

- How to interpret the ratio; and
**What particular user needs this ratio addresses**. (You must have an understanding of users’ needs of financial statements; please refer the topic 1- financial statement users for details).**INTERPRETATION ALONG WITH OTHER RATIOS**

A ratio gives useful information however when interpreted along with other ratios, the meaning and usefulness of ration increases manifolds. Therefore I will teach you what a ratio means when interpreted with the combination of several other ratios.

**HOW TO IMPROVE RATIO?***(short term solvency ratios)*

Although improving the ratio is concern of** management as compared to external users **but I find it appropriate to include it here as management is responsible for taking care of several users (i.e. both at input and output level).

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