What is a liquidity ratio?

A liquidity ratio is fundamentally a financial metric that assesses a company's ability to meet its short-term obligations such as debts and payables. This ratio is crucial because it provides insight into the financial health and operational efficiency of a business by indicating whether it has sufficient liquid assets to cover its current liabilities.

By calculating liquidity ratios, such as the current ratio and quick ratio, stakeholders can make informed judgments about whether the company is in a good position to pay its bills. A company with strong liquidity is generally seen as less risky by investors and creditors, as it shows that the company can manage its short-term financial commitments effectively.

The other options do not correctly represent the concept of liquidity ratios. For instance, measuring return on investment relates more to profitability rather than liquidity, and comparing long-term debt to equity is a measure of financial leverage, not short-term payment capability. Similarly, evaluating employee performance falls outside the scope of financial metrics related to a company’s liquidity.