Liquidity Ratio

Liquidity ratio is a ratio that measures a person’s capacity to fulfil regular expenses in the case of a contingency or unexpected incident. It is also known as emergency fund ratio. 

The liquidity ratio typically can be used to calculate how many months’ the expenses are covered by liquid money, such as cash or near-cash assets.

Liquid assets include cash, savings accounts, money market funds, and easily marketable securities, and liquid funds, that can be quickly sold at a fair market price. Monthly expenses include short-term debts, credit card balances, outstanding bills, and other obligations due within a year.

Let us understand with an example.

Example: Mr. Rakesh is a software engineer who has Rs 30,000 as cash at home & Rs 45,000 in Savings Account. His monthly expenses are around Rs 15,000. What would be his Liquidity Ratio?

Liquidity ratio = (30000 + 45000) / 15000 = 5.00

It is recommended that you have 3-6 months of spending in your emergency fund, which indicates that your liquidity ratio should be between 3 and 6. Having a solid emergency fund can provide peace of mind and protect against financial setbacks. It’s important to regularly monitor and assess your liquidity ratio as part of your overall financial planning to ensure you have adequate liquidity and financial stability. However, the ideal liquidity ratio can vary depending on individual circumstances, risk tolerance, and financial goals. Therefore, it’s essential to consider your unique situation and consult with a financial advisor to determine an appropriate target liquidity ratio that aligns with your financial goals and objectives.