Firstly, the liquidity ratio as adequate liquidity is quite important since it indicates the firm’s ability to meet current/short term obligations. Creditors are interested in the short term solvency of a firm.

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Current ratio is one important component/type or liquidity ratio. It measures firm’s short term solvency i.e. its ability to meet short term obligations by comparing the current assets and current liabilities. The higher the current ratio, the larger the amount of  rupees available per rupee of current liability, the more is the firm’s ability to meet current obligations & assures greater safety of funds of short term creditors.

 

Secondly the leverage/capital structure ratio. These ratios throw light on the long term solvency of a firm. It judges the soundness of a firm in terms of its ability to pay the interests regularly to long term creditors & repayment of principal on maturity.

Among the leverage ratios, the debt-equity is one of the important ones. It shows the relationships between borrowed funds and owner’s capital to measure the long term financial solvency of the firm. This ratio reflects the relative claims of the creditors & shareholders against the assets of the firm. Alternatively, it includes the relative proportions of debt & equity in financing the assets of the firm.

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