Calculating Liquidity Ratios

Systems and Coordination

Calculating Liquidity Ratios

Liquidity Ratios measure the amount of liquidity the business has to cover its debt and provide a high-level overview of financial health. Here are the most common and what you can learn by calculating liquidity ratios.

Dr. David L. HarkinsOctober 5, 2017

Liquidity Ratios measure the amount of liquidity the business has to cover its debt and provide a high-level overview of financial health.

These ratios include:

CURRENT RATIO (Also known as the Working Capital Ratio)

The Current Ratio measures the company's ability to generate cash to meet short-term financial commitments. The formula is as follows:

Current Ratio =Current/Current Liabilities

The current ratio serves as an early warning sign of the business's possible cash flow issues for investors and lenders.

QUICK RATIO (Also known as the "Acid Test")

The Quick Ratio measures the business's ability to access cash quickly for immediate demands. The formula is as follows:

Quick Ratio = Current Assets - Inventories/Current Liabilities

A ratio of 1.0 or greater is acceptable, but it is industry dependent. Generally speaking, investors prefer a higher quick ratio.

If you would like to learn more about Financial Ratios and how they may be used, read the post, Financial Ratio Analysis and the Entrepreneur.

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Reference

Rogers, S. (2014). Entrepreneurial Finance: Finance and Business Strategies for the Serious Entrepreneur. New York: McGraw Hill Education.

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