Liquidity means the ability of business unit to pay short term liabilities. Short term liabilities means current liabilities.

Liquidity ratios are

1. Current ratio
2. Liquid ratio.

Explanation of Current Ratio: Current ratio shows the relationship between current assets and current liabilities. If the proportion of current assets is higher than current liabilities then the liquidity position of business entity is good and more liquidity means more short-terms solvency.

Formula : Current ratio =  Currrent Assets / Current Liabilities 
Current assets means that which is in the cash form or cash equivalent or which can be converted into cash within 12 months or which can be converted into cash equivalent. Examples of Current Assets: Current investment, stock (Excluding loose tools), trade receivables, cash and cash equivalent, short term lendings and advances, expenses paid in advance, incomes outstanding, taxes paid in advance etc.
Current liabilities means such liabilities which are payable within the time period of 12 months.

• Examples of Current Liabilities: Short term borrowings, trade payables, interest payable on long term liabilities, due but not paid liability, due but not paid interest, expenses outstandings, uncalled dividend, Installments received in advance, short-term provisions etc.
• Proportions for liquidity ratio 2: 1 is desirable
• The difference of current assets and current liabilities is known as working capital.