Utah Contractor Practice Exam

Which ratios measure the ability of a company to meet its short-term debt obligations?

1. Profitability ratios

2. Leverage ratios

3. Liquidity ratios

4. Return on Investment ratios

The correct answer is: Liquidity ratios

Liquidity ratios are critical for assessing a company's capability to meet its short-term debt obligations. These ratios provide insights into the financial health of a company by measuring the relationship between its liquid assets and its current liabilities. For instance, common liquidity ratios include the current ratio and the quick ratio. The current ratio compares current assets to current liabilities, indicating whether a company has enough assets to cover its short-term debts. The quick ratio, which excludes inventory from current assets, gives a more stringent view by focusing on the most liquid assets. Both of these ratios help stakeholders understand whether a company can fulfill its financial commitments as they come due, which is crucial for operational stability and maintaining credibility with creditors and suppliers. Profitability ratios focus instead on a company's ability to generate earnings relative to its expenses and revenue, providing insights into overall profitability rather than liquidity. Leverage ratios assess the degree to which a company uses borrowed funds to finance its operations, but they do not directly measure short-term debt repayment ability. Return on Investment (ROI) ratios evaluate the efficiency of an investment relative to its cost but are not designed to assess liquidity or short-term obligations. Thus, understanding liquidity ratios is essential for anyone involved in financial management, lending, or investing, as they directly indicate timeliness