Which financial measure can indicate a company's ability to cover its short-term liabilities?

Which financial measure can indicate a company's ability to cover its short-term liabilities?

• A. Debt-to-equity ratio
• B. Current ratio
• C. Return on equity
• D. Earnings before interest and taxes (EBIT)

Answer: (B)

The current ratio is a key financial metric that measures a company's ability to pay its short-term liabilities with its short-term assets. It is calculated by dividing current assets by current liabilities. A higher current ratio suggests that the company has more assets readily available to cover its obligations, indicating a stronger liquidity position. This is particularly important for assessing a company's short-term financial health and ability to meet immediate financial commitments. In contrast, the debt-to-equity ratio focuses on the relationship between a company's total debt and its shareholders' equity, which is more about long-term financial leverage rather than short-term liquidity. Return on equity measures the profitability generated from shareholders' equity, providing insight into operational efficiency and profitability, but not liquidity. Earnings before interest and taxes (EBIT) is a measure of a company's profitability without considering financing costs and does not directly address liquidity or the ability to cover short-term liabilities. Therefore, the current ratio is the most relevant measure for indicating a company's capacity to manage its short-term financial obligations effectively.

The current ratio is a key financial metric that measures a company's ability to pay its short-term liabilities with its short-term assets. It is calculated by dividing current assets by current liabilities. A higher current ratio suggests that the company has more assets readily available to cover its obligations, indicating a stronger liquidity position. This is particularly important for assessing a company's short-term financial health and ability to meet immediate financial commitments.

In contrast, the debt-to-equity ratio focuses on the relationship between a company's total debt and its shareholders' equity, which is more about long-term financial leverage rather than short-term liquidity. Return on equity measures the profitability generated from shareholders' equity, providing insight into operational efficiency and profitability, but not liquidity. Earnings before interest and taxes (EBIT) is a measure of a company's profitability without considering financing costs and does not directly address liquidity or the ability to cover short-term liabilities.

Therefore, the current ratio is the most relevant measure for indicating a company's capacity to manage its short-term financial obligations effectively.