The liquidity of a business firm is measured by its ability to satisfy its long-term obligations as they become due. What are the ratios used for this purpose?
The statement in the question is factually incorrect. Liquidity measures the ability to satisfy short-term obligations (current obligations), not long-term obligations. Liquidity ratios include Current Ratio and Liquid Ratio.
The ability to satisfy long-term obligations is measured by Solvency Ratios. These ratios determine the ability of the business to service its debt in the long run. The solvency ratios include: Debt-Equity Ratio, Debt to Capital Employed Ratio, Proprietary Ratio, Total Assets to Debt Ratio, and Interest Coverage Ratio.
These ratios are essentially long-term in nature and help evaluate the solvency position of the business towards external stakeholders.
Explanation
The question contains a conceptual error that students must identify. According to the textbook, liquidity ratios measure short-term solvency (current obligations), while solvency ratios measure long-term obligations. The context clearly states: 'Liquidity ratios are calculated to measure the short-term solvency of the business' and 'Solvency ratios are calculated to determine the ability of the business to service its debt in the long run.' The Test your Understanding section also confirms that liquidity relates to short-term obligations. Students should correct this misconception and provide the appropriate solvency ratios for measuring long-term obligations.