Liquidity Ratios are an important subgroup of financial ratios for business owners to understand and utilize in running their business.
What are Liquidity Ratios?
Liquidity ratios are formulas that put two numbers from your business’ Balance Sheet or Cash Flow Statement in contrast with one another, in order to create a helpful financial ratio. This family of financial ratios analyzes how successfully your business can pay off its current obligations with various sources of funding.
Depending on which figures and formulas you choose to emphasize, Liquidity Ratios may be more or less conservative in painting your current financial picture.
Balance Sheet: A core financial statement that records a snapshot of a company’s assets, liabilities, and equity at the time of publication. For more information about the Balance Sheet, read our helpful blog post!
Cash Flow Statement: Another core financial statement that summarizes the flow of cash and cash equivalents entering and leaving a business over a set period of time.
Current assets: a company’s short-term assets include cash and cash equivalents, accounts receivable, inventory, prepaid expenses, and other liquid assets. Short-term or current since they are expected to be sold, consumed or otherwise exhausted within 12 months.
Current obligations: Also called Current liabilities, these are a company’s short-term financial obligations, due within one calendar year. Current liabilities can include accounts payable, short-term debt, dividends, and taxes owed, among other financial obligations.
What can Liquidity Ratios tell me about my business?
To put it simply, Liquidity Ratios tell you if your business can pay current obligations or liabilities. Liquidity Ratios will provide you with a number that indicates how much of a financial cushion you have, by presuming these debts will be paid by various sources of liquid assets available within your company.
Liquidity ratios are also used by lenders to figure out whether or not to extend credit or loans to a business. Better Liquidity Ratios mean your company is in a more stable financial position, and more likely to be approved for additional funding.
The liquidity ratios cover the following: