Liquidity ratios are used to measure a firm's ability to meet its obligations as they come due. Two of the most commonly used liquidity ratios are the: (1) Current ratio and (2) Quick, or acid test, ratio. The current ratio is the most commonly used measure of solvency. Its equation is:

Current Ratio = Current Assets / Current Liabilities

Explanation:

Current Ratio = Current Assets / Current Liabilities

The current ratio is an important measure of a company's ability to pay its short term obligations. It is defined as current assets divided by current liabilities.

Current assets are cash and other resources that are expected to be sold or used within one year or the company's operating cycle, whichever is longer. Examples are cash, short term investments, accounts receivable, short term notes receivable, goods for sale (called merchandise or inventory) and prepaid expenses. Prepaid expenses are usually listed last because they will not be converted to cash (instead they are used).

Current liabilities are obligations due to be paid or settled within one year of operating cycle, whichever is longer. they are usually settled by paying out current assets such as cash. Current liabilities often include accounts payable, notes payable, wages payable, taxes payable, interest payable and unearned revenues. Also any portion of a long term liability due to be paid within one year or the operating cycle whichever is longer is a current liability.