Which ratio is a key indicator of liquidity risk?

Which ratio is a key indicator of liquidity risk?

• A. Debt-to-equity ratio
• B. Current ratio
• C. Return on investment
• D. Price-to-earnings ratio

Answer: (B)

The current ratio is a key indicator of liquidity risk because it measures a company's ability to meet its short-term obligations with its short-term assets. Specifically, the current ratio is calculated by dividing current assets by current liabilities. A higher current ratio implies that the company has a larger proportion of assets available to cover its liabilities, which indicates better liquidity and a lower risk of insolvency in the near term. This ratio is crucial for assessing liquidity because it directly addresses whether an organization has sufficient resources to pay off its immediate debts. In contrast, ratios that pertain to profitability or capital structure, such as the debt-to-equity ratio, return on investment, and price-to-earnings ratio, do not focus on liquidity and therefore are not suitable indicators of liquidity risk. The current ratio specifically serves the purpose of assessing how well a company can manage its short-term financial obligations, making it the appropriate choice when considering liquidity risk.

The current ratio is a key indicator of liquidity risk because it measures a company's ability to meet its short-term obligations with its short-term assets. Specifically, the current ratio is calculated by dividing current assets by current liabilities. A higher current ratio implies that the company has a larger proportion of assets available to cover its liabilities, which indicates better liquidity and a lower risk of insolvency in the near term.

This ratio is crucial for assessing liquidity because it directly addresses whether an organization has sufficient resources to pay off its immediate debts. In contrast, ratios that pertain to profitability or capital structure, such as the debt-to-equity ratio, return on investment, and price-to-earnings ratio, do not focus on liquidity and therefore are not suitable indicators of liquidity risk. The current ratio specifically serves the purpose of assessing how well a company can manage its short-term financial obligations, making it the appropriate choice when considering liquidity risk.