The most basic ratio used to measure liquidity is the current ratio.
The calculation: Current Assets / Current Liabilities = Current Ratio
Example: $300,000 / $100,000 = 3
Where to get the numbers:
Current Assets are a subtotal on the Balance Sheet. Cash and other assets that can be reasonably converted to cash during a normal operating cycle (usually about one year) are classified as a current asset. Accounts include cash, short-term investments, accounts receivables, prepaid expenses and inventory.
Current Liabilities are another subtotal on the Balance Sheet. Obligations that must be satisfied during a normal operating cycle (usually about one year) are classified as a current liability. Accounts include trade accounts, short-term notes payable, payroll liabilities and sales and excise taxes payable.
What it means:
The current ratio shows the amount of assets available to pay current obligations. In our example, $3 in current assets are available to repay every $1 in current liabilities. Interested parties, such as lenders or suppliers, like to see a current ratio larger than 1. A ratio of 1.5 is usually considered strong.
A business must hold a certain amount of cash to meet obligations. However, cash does not earn a large return. Instead of holding a non-productive asset, the cash could be put toward other uses that would make more money. The current ratio assesses how the business is balancing their use of cash.