Liquidity, Activity, and Debt Ratios Measure Risk

Liquidity, activity, and debt ratios are financial ratios that primarily measure the risk associated with a company's operations and financial structure. These ratios provide insights into the company's ability to meet its short-term obligations, efficiently utilize its assets, and manage its debt levels. Let's take a closer look at each ratio category:

Liquidity Ratios:
Liquidity ratios assess a company's ability to meet its short-term financial obligations. These ratios measure the company's ability to convert its current assets into cash to pay off its current liabilities. Examples of liquidity ratios include the current ratio and the quick ratio.

- Current Ratio: This ratio compares a company's current assets to its current liabilities. A higher current ratio indicates a better ability to meet short-term obligations.
- Quick Ratio: Also known as the acid-test ratio, this ratio measures a company's ability to pay off its current liabilities using its most liquid assets. It excludes inventory from current assets since inventory may take time to convert into cash.

Activity Ratios:
Activity ratios, also known as asset management ratios, evaluate how efficiently a company utilizes its assets to generate sales and profits. These ratios measure the company's operational efficiency and effectiveness. Examples of activity ratios include the inventory turnover ratio and the accounts receivable turnover ratio.

- Inventory Turnover Ratio: This ratio indicates how many times a company's inventory is sold and replaced within a specific period. A higher ratio suggests efficient inventory management.
- Accounts Receivable Turnover Ratio: This ratio measures how quickly a company collects payments from its customers. A higher ratio indicates effective credit and collection policies.

Debt Ratios:
Debt ratios assess a company's financial risk by measuring its leverage and ability to repay its long-term debt. These ratios analyze the company's capital structure and its ability to handle debt obligations. Examples of debt ratios include the debt-to-equity ratio and the interest coverage ratio.

- Debt-to-Equity Ratio: This ratio compares a company's total debt to its shareholder's equity. It indicates the proportion of financing provided by creditors versus shareholders.
- Interest Coverage Ratio: This ratio evaluates a company's ability to cover its interest expenses with its operating income. A higher ratio suggests better ability to meet interest obligations.

Conclusion:
Among the given options, liquidity, activity, and debt ratios (option C) are the most relevant ratios for measuring risk. These ratios provide insights into a company's ability to meet short-term obligations, efficiently utilize assets, and manage debt levels. By analyzing these ratios, investors and stakeholders can assess the risk associated with a company's financial health and make informed decisions.