Liquidity ratios

Liquidity ratios form an indicator by which the solvency of a company can be measured. In the calculation, assets are compared with short-term liabilities. Assets of a company can be converted into liquid funds at different speeds, and thus three different degrees of liquidity are distinguished.

Liquidity Level 1

Liquidity Level 1 measures the liquid funds of a company in relation to its short-term liabilities. This is to measure whether the company is able to pay off its short-term debts with the available liquid funds. If the Liquidity Level 1 of a company is below 1 (100%), it means, from an academic perspective, that the company does not have sufficient cash to settle its short-term liabilities. If it is at 1 (100%) or higher, the company has the necessary liquidity to pay off the short-term liabilities. In Germany, Austria, and Switzerland, a Liquidity Level 1 of 0.3 (30%) or more is considered sufficient, as most companies actively use their cash for their economic purposes. Liquidity Level 1 is rarely used for fundamental analysis of a company and its liquidity.

Liquidity Level 2

Liquidity Level 2 assesses the ratio between liquid funds and short-term receivables to short-term liabilities, and thus the ability to repay these short-term outstanding liabilities. Short-term receivables include, in particular, receivables from deliveries and services. Generally, companies that show a Liquidity Level 2 of less than 1 (100%) should be careful. Companies that show a too high Liquidity Level 2 suggest that they are not using their assets appropriately to achieve an optimal result and that they are letting their cash sit unused. In this case, the company should look for measures to reinvest the money or use it in other productive ways.

Liquidity Level 3

Liquidity Level 3 is a liquidity ratio that assesses a company's ability to repay its short-term liabilities, which generally fall due within one year. A ratio of total current assets to short-term liabilities of less than 1.2 (120%) may indicate that the company has taken on too many short-term debts relative to its assets. If the short-term ratio is lower than the industry average, this may be an indication of high risk for the company. Conversely, if the company's current assets are significantly above the industry average, this is also a bad sign, as it means that the assets are not being fully utilized.