A liquidity ratio is a measurement which is used to indicate whether a debtor will be able to pay their short-term debt off with the cash they have readily available, or whether they’ll need to raise additional capital to cover the amount. This kind of metric can also show how swiftly the assets held by the debtor can be turned into cash for the debt.
There are a number of different liquidity ratios that can show the status of the debtor – these include the current ratio, the quick ratio, the operation cash flow ratio, working capital, working capital ratio and the absolute liquid ratio. When used in conjunction with each other, these metrics can give a comprehensive overview of how likely it is that the debtor can pay of their debt without raising extra capital.
When we talk about liquidity, we’re talking about how quickly or easily a company’s assets can be turned into cash without losing their value. The more liquid the assets of a business, the more quickly they can get cash to pay off their debt.
Liquidity ratios are what creditors (and sometimes debtors) use to work out if a company can repay creditors from the total cash they have available. The higher the liquidity ratio is for that company, the more liquid their assets are and the more able they’ll be to pay off short-term debts.
The most common liquidity ratio used is the current ratio. The current ratio gives an indication of the company’s ability to pay off current debts using the entirety of the assets the company has available. The formula for working out the current ratio looks like this: Current Ratio = Current Assets ÷ Current Liabilities. If the current ratio is higher than 1.00, it means the cash available covers the short-term liabilities. Find out more about this kind of ratio with our current ratio guide.
Another much-used liquidity is the quick ratio or acid test ratio. Unlike the current ratio which takes into account all of the assets of a company, the quick ratio focuses on the business’ quick assets - that is to say, highly liquid assets that can be turned into cash swiftly and without losing too much of their book value. The formula for this kind of liquidity ratio is: Quick Ratio = Liquid Assets ÷ Quick Liabilities. As with the current ratio, a quick ratio of higher than 1.00 means that the full debts can be paid. We’ve also written a full guide on quick ratios to give you a better idea.
Invoice finance allows you to release cash quickly from your unpaid invoices.
As your lender, we can release up to 90% of your invoices within 24 hours. On payment of the invoice from your customers, we will then release the final amount minus any fees and charges. There are different types of invoice financing options available to businesses depending on the situation and the level of control they require in collecting unpaid invoices.
We are an invoice financing company who offer a solution whereby payments are collected on your behalf managed by our team of expert credit controllers so you can focus on running your business. Our Confidential Invoice Discounting solution is offered to businesses who want to maintain their own credit control processes, therefore this remains strictly confidential so your customers are unaware of our involvement.
The biggest difference between a liquidity ratio and a solvency ratio is the time and length of the debts and obligations in question.
As we have seen, a liquidity ratio deals with short-term or current loans – giving an indication of a business’ ability to deal with those short-term obligations. They show the liquidity of the company’s assets.
Solvency ratios deal with the long-term view, which includes long-term debts and the complete array of financial obligations that a business can have.
If your liquidity ratio for your business is higher than one, then your company is in good financial shape and will be able to take on financial challenges in the future. The higher the liquidity ratio, the healthier your businesses finances will be.
Anything below one and you should be considering strategies to improve the way your business works to keep yourself financially protected.
While there are a number of different kinds of liquidity ratio you can calculate for your business, the most common ones are the current ratio, the quick ratio and the cash flow ratio. Using a combination of these three liquidity ratios can provide a clear look at the performance of your business from a financial perspective.
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