The Importance of Liquidity Ratios in your business.

7 August 2016

Admin User

Liquidity ratios are important to businesses as they measure the ability for a business to pay its bills.

A business must have significant cash reserves to cover its Cash Conversion Cycle (CCC).  www.mcnamaraandcompany.com.au/blog/why-is-a-healthy-cash-conversion-cycle-ccc-important-to-a-business

The CCC is how long it takes for a business to pay for its inventory of cost of services; sell them and then collect the cash from its customers / clients.

Some other liquidity ratios are below:

The Cash Ratio

The Cash Ratio is vital to your businesses survival and a very effective liquidity measure.

It is calculated as follows:
Cash and cash equivalents / current liabilities.

It is a very conservative measure in that it omits inventory and accounts receivable (debtors)

The ratio can change dramatically on a daily basis as your clients / customers pay you and you pay your suppliers.


Defensive Interval Ratio

Calculates how long a business can continue to pay its suppliers / liabilities.

The Defensive Interval Ratio is calculated as follows:

(Cash + Marketable Securities + Trade Accounts Receivables) / Average daily expenditure.    


Quick Ratio

The Quick Ratio is similar to the Cash Ratio except that it factors in accounts receivable.

The ratio is designed to see if a business has sufficient cash reserves to pay its current liabilities.  Inventory is omitted from the ratio as it can be difficulty to sell inventory quickly.

The Quick Ratio is calculated as follows:

(Cash + marketable securities + accounts receivable) / current liabilities.

 

If you would like to discuss further please contact us:
McNamara and Co - Chartered Accountants, located minutes from the Melbourne CBD
www.mcnamaraandcompany.com.au/contact-us
Phone +61 3 9428 1062
Email admin@mcnamaraandco.com

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