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Liquidity vs. Solvency

Though frequently used interchangeably, liquidity and solvency are different measures and the differences should be understood. Liquidity refers to the ability of a firm to mobilize assets and use them to service debt, fund current operations, and react quickly to changing business conditions. It is a short-term concept. Ratios commonly used to measure liquidity are:

Current Ratio is a measure of ability to cover current debts with current assets.

Current Ratio


current ratio


Calculate your company's current ratio:

Current Ratio
Description Your Input
Current Assets
Current Liabilities
Current Ratio Calculations

An even shorter-term ratio is the Quick Ratio.
Quick Ratio (a.k.a. Acid Test).

quick ratio or acid test


The Quick Ratio is a short-term liquidity measurement that excludes inventory from quick assets available, but inventory is included in the Current Ratio. Note that these ratios assume that accounts receivable are current and can be misleading if a company carries significant accounts receivable on the books that are long overdue and whose collectability in the short term is questionable.


Calculate your company's quick ratio:

Quick Ratio
Description Your Input
Cash
Marketable Securities
Accounts Receivable
Current Liabilities
Quick Ratio Calculations

Solvency, though related to liquidity, refers to a firm’s overall credit picture and its ability to fulfill long-term obligations and secure funding in the future. It is related to the overall capital structure of a firm, its degree of financial leverage, and the risk associated with that structure.

It is not uncommon for a company to have a high degree of liquidity but be insolvent or for a company with a strong balance sheet and high solvency to be suffering a temporary lack of liquidity.

Liquidity = ability to quickly access cash and near-cash assets to satisfy current debt service and operations.

Solvency = strong balance sheet with manageable debt ratios, leverage, and risk that is low enough to maintain access to ongoing funds should the need arise.

As mentioned previously, debt, when used carefully and appropriately, can fund growth, provide financial leverage, and compensate for business fluctuations. Excessive or inappropriate debt is dangerous and must be avoided through thoughtful debt management.


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