Certified Financial Management Specialist Practice Exam

What do liquidity ratios assess?

1. The firm's profitability

2. The firm's ability to pay short-term debts

3. The firm's long-term financial health

4. The firm's revenue growth

The correct answer is: The firm's ability to pay short-term debts

Liquidity ratios are a key financial metric used to assess a firm's ability to meet its short-term obligations using its most liquid assets. These ratios, such as the current ratio and quick ratio, specifically measure the capability of a company to cover its current liabilities with its current assets. This is crucial for understanding whether the business can efficiently handle its short-term debts and maintain operations without financial strain. The focus of liquidity ratios is distinctly on short-term financial health rather than long-term profitability or growth metrics. As a result, they provide stakeholders and management with insights into the firm's immediate financial stability and operational efficiency. By analyzing liquidity ratios, one can gauge how well a company can respond to short-term challenges, such as unexpected expenses or declines in cash flow, without resorting to borrowing or selling assets. This makes option B the correct choice in understanding the primary purpose of liquidity ratios.