How is the liquidity ratio calculated?

The liquidity ratio, often referred to in financial contexts, is intended to assess the ability of a company to meet its short-term obligations. The correct calculation involves focusing on both current assets and current liabilities, specifically measuring how effectively current assets can cover those liabilities.

By using the formula that adds inventory to current assets and then divides by current liabilities, it reflects a more comprehensive view of liquidity. This is essential as inventory, while not as liquid as cash or receivables, can still contribute to the funds available for meeting obligations.

This particular ratio aims to establish a relationship between liquid assets and liabilities, which is crucial for evaluating short-term financial health. It gives a clearer picture of how a business can use its assets to satisfy short-term debts, demonstrating a vital aspect of financial management that informs operational and strategic decisions.

The other options present different ratios or interpretations of liquidity that do not align with the standard method for calculating liquidity ratio. These variations do not correctly assess the immediate ability of a company to cover its liabilities with its current assets.