Liquidity Ratios

Current Ratio How well is your business positioned to pay its current bills over the next 12 months. If these ratios are below normal or trending downward - it could be an eye opening sign that your business is in financial chaos and, if steps are not taken NOW, could be out of business very quickly.
  • Current Assets:    What are current assets?
  • Current Liabilities:    What are current liabilities?
    Interpret Your Results
  • Try to think about this ratio in terms of dollars.
  • A ratio of 1.75 would show that the business has $1.75 of current assets to cover each $1.00 in current liabilities.
  • This number should always be greater than 1 - if it is not, your business has more bills to pay then liquid assets to pay them.
  • For most businesses, this ratio hovers between 1.50 to 1.90
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  • Click Here - to see possible ways to improve this ratio
  • Current Ratio:

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Quick Ratio While current assets (from above) can include assets that can be converted to cash within a year - very few suppliers, landlords or other creditors will wait that long to get paid.
The Quick Ratio is a measure to determine if your business can satisfy its immediate (under 90 day) obligations using extremely liquid assets.
  • Cash:    What is cash?
  • Accounts Receivables:    What are accounts receivables?
  • Current Liabilities:    What are current liabilities?
    Interpret Your Results
  • Try to think about this ratio in terms of dollars.
  • A ratio of 0.75 would show that your business has $0.75 in very liquid assets to cover all your current obligations (some of which may not be due immediately).
  • Note: For service businesses the current and quick ratios are usually very similar.
  • This ratio usually averages between 0.70 and 0.90
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  • Click Here - to see possible ways to improve this ratio
  • Quick Ratio:

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Ways to Improve: Current Ratio: The most obvious way to improve this ratio and better position your business to cover its short-term obligations is to better manage your current liabilities (more specifically your accounts payables) - the least amount of obligations your business has, the more its current assets will cover (however, just taking cash - a current asset - and paying accounts payables - a current liability - keeps this ratio unchanged). The goal is to have more current assets than liabilities - assets that can be used to grow or expand the business. This could be done by:

  • Financing your operating cycle by means other than current liabilities - like using equity, cash or long-term debt.
Or, the business could also increase current assets faster than current liabilities - meaning adding cash to the business or increasing other current assets like accounts receivables, inventory or prepaid expenses faster than liabilities increase (however, none of this should be done at the expense of the business e.g. not collecting receivables in a timely manner (cash is always better), unnecessarily increasing inventory or recklessly spending cash on items like prepaid expenses; cash that could be used for growth and development).

The goal is to generate cash, accounts receivables or inventory without having to spend cash or finance them with current liabilities (debt or payables). This could be done by:

  • Generate more profit (cash) out of each sale by increasing profit (as long as it is competitive within your industry), reducing your costs of goods sold (making your product with less cost or providing your service with less costs) or finding efficiencies throughout your operating cycle.
  • Purchasing inventory with cash, equity or long-term debt - not current obligations (long-term debt is not recommended to finance short-term needs or working capital).
  • Generating cash or receivables that do not rely on some type of financing - debt or trade payables.
- Back to Current Ratio -

Quick Ratio: As the quick ratio measures your companies ability to quickly liquidate assets or use cash on hand (assets that convert to cash in under 90 days) to pay business obligations like suppliers, landlords, taxes due, etc, your actions to improve this ratio and ultimately your business are similar to the current ratio above. The goal is to generate cash through your business without having to finance the growth (debt or payables).

- Back to Quick Ratio -

Other financial ratio calculations you may want to evaluate:

Disclaimer: These ratios are for education purposes only and are in no way an adequate substitute for a professional financial advisor.

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Financial Ratios - Liquidity