Liquidity measures a company’s ability to pay its short-term debts. A business can be profitable on paper and still run out of money to pay tomorrow’s bills: that is a major risk.

The ratio to know

The current ratio compares short-term assets with short-term debts: current assets ÷ current liabilities.

• Above 1: the company can cover its immediate debts. Reassuring.
• Below 1: a warning sign, cash may run short.
• Far too high: money may be sitting idle for no reason.

Liquidity explains why profitable companies go under: they simply do not have enough cash available at the right moment.

Key takeaway: profitability and liquidity are two different things. A current ratio below 1 should always put you on alert.