Future Business Leaders of America (FBLA) Business Calculations Practice Test

Which ratio indicates how well a company can pay off its short-term debt?

1. Efficiency ratio

2. Leverage ratio

3. Liquidity ratio

4. Profitability ratio

The correct answer is: Liquidity ratio

The chosen ratio that indicates how well a company can pay off its short-term debt is known as the liquidity ratio. This ratio measures a company's ability to meet its short-term financial obligations with its most liquid assets. Key liquidity ratios include the current ratio and the quick ratio. The current ratio, which is calculated by dividing current assets by current liabilities, shows the extent to which current assets can cover current liabilities. A higher current ratio suggests that a company is in a better position to pay off its short-term debts. Conversely, the quick ratio takes a more conservative approach by excluding inventory from current assets, providing an even clearer picture of a company's liquidity in case of sudden cash needs. In contrast, the efficiency ratio assesses how effectively a company uses its assets to generate revenue, the leverage ratio looks at the degree to which a company is using borrowed money to finance its assets, and the profitability ratio measures a company's ability to generate profit relative to its revenue, assets, or equity. These metrics provide valuable insights into different aspects of a company's financial health, but they do not directly address its ability to cover short-term liabilities like the liquidity ratio does.