CSLB Law & Business ExamBusiness FinancesEasy
A contractor is evaluating the company's ability to cover its short-term debts with its most liquid assets. Which financial ratio would be most appropriate for this assessment?
- ADebt-to-Equity Ratio
- BReturn on Assets
- CQuick Ratio
- DGross Profit Margin
Show answer & explanationAnswer & explanation
Correct answer: C. Quick Ratio
The Quick Ratio, also known as the Acid-Test Ratio, specifically measures a company's ability to pay its current liabilities with its most liquid assets (excluding inventory), making it ideal for assessing immediate liquidity.
Why the other options are wrong
- A. The Debt-to-Equity Ratio measures financial leverage, not short-term liquidity.
- B. Return on Assets measures how efficiently a company uses its assets to generate earnings, not liquidity.
- D. Gross Profit Margin measures profitability from sales, not liquidity.
Quick Ratio (Acid-Test Ratio)
A liquidity ratio that measures a company's ability to meet its short-term obligations with its most liquid assets, excluding inventory.
- Calculated as (Current Assets - Inventory) / Current Liabilities.
- Indicates immediate liquidity.
- A higher ratio generally suggests better short-term financial health.
Memory trick: Liquid assets quickly cover short-term debts.