What is a strong liquidity ratio?
In short, a “good” liquidity ratio is anything higher than 1. Having said that, a liquidity ratio of 1 is unlikely to prove that your business is worthy of investment. Generally speaking, creditors and investors will look for an accounting liquidity ratio of around 2 or 3.
- Current Ratio = Current Assets / Current Liabilities.
- Quick Ratio = (Cash + Accounts Receivable) / Current Liabilities.
- Cash Ratio = (Cash + Marketable Securities) / Current Liabilities.
- Net Working Capital = Current Assets – Current Liabilities.
Ideal Liquid Ratio is 1 : 1.
The measures include bid-ask spreads, turnover ratios, and price impact measures. They gauge different aspects of market liquidity, namely tightness (costs), immediacy, depth, breadth, and resiliency.
Conversely, if the company's ratio is 0.8 or less, it may not have enough liquidity to pay off its short-term obligations. If the organization needed to take out a loan or raise capital, it would likely have a much easier time in the first instance.
Understanding High Liquidity
If a company has plenty of cash or liquid assets on hand and can easily pay any debts that may come due in the short term, that is an indicator of high liquidity and financial health. However, it could also be an indicator that a company is not investing sufficiently.
A Liquidity Ratio of 1.5 means that a company has $1.50 in liquid assets for every $1 of its current liabilities, indicating that the company can cover its short-term obligations.
Liquidity ratios are a measure of the ability of a company to pay off its short-term liabilities. Liquidity ratios determine how quickly a company can convert the assets and use them for meeting the dues that arise. The higher the ratio, the easier is the ability to clear the debts and avoid defaulting on payments.
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.
Liquidity ratios are an important class of financial metrics used to determine a debtor's ability to pay off current debt obligations without raising external capital. Common liquidity ratios include the quick ratio, current ratio, and days sales outstanding.
What's a good quick ratio?
Generally speaking, a good quick ratio is anything above 1 or 1:1. A ratio of 1:1 would mean the company has the same amount of liquid assets as current liabilities. A higher ratio indicates the company could pay off current liabilities several times over.
Creditors and investors like to see higher liquidity ratios, such as 2 or 3. The higher the ratio is, the more likely a company is able to pay its short-term bills. A ratio of less than 1 means the company faces a negative working capital and can be experiencing a liquidity crisis.
It's also important to maintain a strong liquidity ratio, which indicates the business is able to pay off its existing debts with its existing assets. The easier an asset is to access quickly, the more liquid it is.
That would mean it has exactly the amount required to pay those short-term liabilities. A quick ratio of 0.5 would mean that a company only has £0.50 in assets for every £1 it owes in short-term liabilities, meaning it would not have enough to meet its short-term liabilities.
Excess liquidity may also push the bankers towards riskier use of deposits in lending and investments in assets with highly volatile collateral value, such as real estate (Agénor & El Aynaoui, 2010).
It can also be a hurdle for business expansion. Excess liquidity suggests to investors, shareholders, and analysts that the firm is unable to effectively utilise the available cash resources or identify investment opportunities that can generate revenues.
The current ratio (also known as working capital ratio) measures the liquidity of a company and is calculated by dividing its current assets by its current liabilities. The term current refers to short-term assets or liabilities that are consumed (assets) and paid off (liabilities) is less than one year.
The current ratio for Company ABC is 2.5, which means that it has 2.5 times its liabilities in assets and can currently meet its financial obligations Any current ratio over 2 is considered 'good' by most accounts.
This ratio focuses primarily on the organization's ability to service debt payments in the near future. A ratio of 1.2 specifically indicates that the organization has $1.20 in liquid assets for every $1.00 of debt requirements.
Apple's current ratio for the quarter that ended in Dec. 2023 was 1.07. Apple has a current ratio of 1.07. It generally indicates good short-term financial strength.
What are the 5 liquidity ratios?
- Current Ratio = Current Assets ÷ Current Liabilities.
- Quick Ratio = (Cash & Equivalents + Marketable Securities + Accounts Receivable) ÷ Current Liabilities.
- Cash Ratio = Cash & Cash Equivalents ÷ Current Liabilities.
- NWC % Revenue = Net Working Capital ÷ Revenue.
- Net Debt = Total Debt – Cash & Cash Equivalents.
Cash ratio calculation
Used most frequently by creditors and financial institutions, the cash ratio is considered the most stringent of the three liquidity ratios, using only cash and marketable securities in its calculation.
The liquidity coverage ratio is the requirement whereby banks must hold an amount of high-quality liquid assets that's enough to fund cash outflows for 30 days. 1 Liquidity ratios are similar to the LCR in that they measure a company's ability to meet its short-term financial obligations.
Cash is the most liquid asset, followed by cash equivalents, which are things like money market accounts, certificates of deposit (CDs), or time deposits. Marketable securities, such as stocks and bonds listed on exchanges, are often very liquid and can be sold quickly via a broker.
- Current Ratio = Current Assets / Current Liabilities.
- Quick Ratio = (Cash and Cash Equivalents + Marketable Securities + Accounts Receivable) / Current Liabilities.
- Cash Ratio = (Cash and Cash Equivalents + Short-Term Investments) / Current Liabilities.
