Overall Liquidity Ratio

Overall Liquidity Ratio

The overall liquidity ratio is the measurement of a company's capacity to pay its outstanding liabilities with its assets on hand. The formula to calculate the overall liquidity ratio is: \[Total Assets / (Total Liabilities – Conditional Reserves)\]. A low overall liquidity ratio could indicate that the financial institution or insurance company is in financial trouble. The overall liquidity ratio can be contrasted with the current ratio and quick ratio, which both focus more on current obligations due within the upcoming 12 months. A low overall liquidity ratio could indicate that the financial institution or insurance company is in financial trouble, whether from poor operational management, poor risk management, or poor investment management. The quick ratio compares a company's assets that are readily available for use, including cash, short-term investments, government bonds, and unaffiliated investments, to its current obligations (short-term liabilities due within the upcoming 12 month period).

The overall liquidity ratio is used in the insurance industry to determine whether an insurer is financially healthy and solvent enough to cover its liabilities.

What is the Overall Liquidity Ratio?

The overall liquidity ratio is the measurement of a company's capacity to pay its outstanding liabilities with its assets on hand. The overall liquidity ratio is calculated by dividing total assets by the difference between its total liabilities and conditional reserves. This ratio is used in the insurance industry, as well as in the analysis of financial institutions.

The overall liquidity ratio is used in the insurance industry to determine whether an insurer is financially healthy and solvent enough to cover its liabilities.
It may also be used in the context of financial institutions, such as banks.
The formula to calculate the overall liquidity ratio is: \[Total Assets / (Total Liabilities – Conditional Reserves)\].
A low overall liquidity ratio could indicate that the financial institution or insurance company is in financial trouble.
The overall liquidity ratio can be contrasted with the current ratio and quick ratio, which both focus more on current obligations due within the upcoming 12 months.

How the Overall Liquidity Ratio is Used

Regulators use financial metrics, like the overall liquidity ratio, to determine whether an insurer, bank, or other company is financially healthy and solvent enough to cover its liabilities. Financial and insurance companies use the cash that their activities generate to obtain a return. A bank, for example, may use funds received from customer deposits to provide mortgages and other loans. The balance of customer deposits that are left over may be kept as cash, or may be invested in liquid assets.

Insurance companies receive money in the form of premium payments by policyholders, and they in turn are liable for the coverage benefits they guarantee by underwriting policies. Depending on the duration of the policy, the liability can last anywhere from a few months to a few years. Liabilities that come due within the following twelve month period are considered to be current liabilities.

The amount of money that a financial institution or insurer has to keep readily available to cover its liabilities is determined by regulators. Regulators examine liquidity ratios to determine whether the company is complying with its legal requirements. The formula to calculate the overall liquidity ratio is: [Total Assets / (Total Liabilities – Conditional Reserves)]. In this calculation, conditional reserves refer to rainy-day funds held by insurance companies to help cover unanticipated expenses during times of financial stress.

Understanding the Overall Liquidity Ratio

A low overall liquidity ratio could indicate that the financial institution or insurance company is in financial trouble, whether from poor operational management, poor risk management, or poor investment management. In order to comply with legal requirements and guarantee sufficient funds to cover its liabilities, most lenders and insurers try to improve their overall liquidity ratio.

However, a high overall liquidity ratio isn’t necessarily good either, especially if current assets represent a high percentage of the company's total assets. A large proportion of current assets means that the company may not be investing sufficiently to earn a high return on assets, but it may instead be focusing solely on liquidity.

Overall Liquidity Ratio vs. Quick Ratio vs. Current Ratio

Other liquidity metrics include the quick ratio and current ratio. The quick ratio compares a company's assets that are readily available for use, including cash, short-term investments, government bonds, and unaffiliated investments, to its current obligations (short-term liabilities due within the upcoming 12 month period). The current ratio compares a company's total current assets to its current obligations. The quick ratio is more conservative than the current ratio because it doesn't take into account current assets such as inventory, which are harder to quickly turn into usable cash.

Related terms:

Asset

An asset is a resource with economic value that an individual or corporation owns or controls with the expectation that it will provide a future benefit. read more

Cash Asset Ratio

The cash asset ratio is the current value of marketable securities and cash, divided by the company's current liabilities.  read more

Conditional Reserves

In order to be able to meet all their obligations, insurance companies maintain conditional reserves accounted for as liabilities. read more

Current Liquidity

Current liquidity is the total amount of cash and unaffiliated holdings compared with net liabilities and ceded reinsurance balances payable. read more

Current Liabilities & Example

Current liabilities are a company's debts or obligations that are due to be paid to creditors within one year. read more

Current Ratio

The current ratio is a liquidity ratio that measures a company's ability to cover its short-term obligations with its current assets. read more

Government Bond

A government bond is issued by a government at the federal, state, or local level to raise debt capital. Treasuries are issued at the federal level. read more

Liability

A liability is something a person or company owes, usually a sum of money. read more

Liquidity

Liquidity refers to the ease with which an asset, or security, can be converted into ready cash without affecting its market price. read more

Liquidity Ratio

Liquidity ratios are a class of financial metrics used to determine a debtor's ability to pay off current debt obligations without raising external capital. read more