Can the company pay its bills?
Liquidity ratios answer a basic question for lenders, suppliers and managers: can the business pay what it owes over the next twelve months with the assets it will turn into cash over the same period? They come straight from the balance sheet: current assets on one side, current liabilities on the other.
The formulas
- Current ratio = current assets ÷ current liabilities
- Quick ratio (acid test) = (cash + receivables) ÷ current liabilities
- Cash ratio = cash and short-term investments ÷ current liabilities
- Net working capital = current assets − current liabilities
Each ratio is stricter than the one before: the quick ratio leaves out inventory, which may take months to sell, and the cash ratio keeps only cash.
Worked example
A company has $50,000 of cash, $80,000 of receivables and $70,000 of inventory, for $120,000 of current liabilities.
- Current assets = $200,000.
- Current ratio = 200,000 ÷ 120,000 = 1.67.
- Quick ratio = 130,000 ÷ 120,000 = 1.08.
- Cash ratio = 50,000 ÷ 120,000 = 0.42.
- Net working capital = $80,000.
Interpretation
| Current ratio | Usual reading |
|---|---|
| Below 1 | Short-term debts exceed current assets |
| 1 to 1.5 | Adequate, with a thin cushion |
| 1.5 to 3 | Comfortable for most industries |
| Above 3 | Very liquid; cash or inventory may be underused |
A quick ratio of 1 or more means the company could pay its current debts without selling any inventory. Lenders often write minimum current or quick ratios into loan covenants.
Industry matters
Grocery chains and restaurants collect cash at the register but pay suppliers later, so they often run with a current ratio below 1 without any trouble. Manufacturers with long production cycles and heavy inventory need higher ratios. Always compare a company with its own history and its industry.
Look behind the numbers
Receivables only count if customers actually pay: check how old they are. Inventory can be obsolete. Seasonal businesses look very different depending on the balance sheet date, and a single ratio can be flattered by delaying payments to suppliers just before year-end. Combine liquidity ratios with cash flow from operations for a fuller picture.
This calculator gives estimates for education and planning. It is not investment, tax or legal advice; for decisions about your own situation, talk to a qualified financial professional.