Which one of the following statements related to liquidity is correct?

• A. Liquidity measures the profitability of a company over a fiscal year.
• B. Liquidity refers to a company's ability to meet its short-term obligations as they come due.
• C. Liquidity is calculated by subtracting total liabilities from total equity.
• D. Liquidity is only relevant for long-term investments and fixed assets.

Answer: (B)

Verified step by step guidance

1. Understand the concept of liquidity: Liquidity refers to a company's ability to meet its short-term financial obligations as they come due. It is a measure of how quickly assets can be converted into cash to pay off liabilities.
2. Identify the incorrect statements: Review each option provided in the problem and determine whether it aligns with the definition of liquidity. For example, liquidity does not measure profitability, nor is it calculated by subtracting total liabilities from total equity.
3. Focus on the correct statement: The correct statement is the one that accurately describes liquidity as the ability to meet short-term obligations. This aligns with the definition provided in step 1.
4. Clarify why other options are incorrect: Liquidity is not related to long-term investments or fixed assets, as these are not typically used to meet short-term obligations. Additionally, profitability is a separate concept from liquidity.
5. Conclude with the correct understanding: Liquidity is a critical financial metric for assessing a company's short-term financial health and its ability to manage immediate obligations effectively.