How to Determine Available Liquidity

The concept of liquidity is extremely important when it comes to the operation of a business. The liquidity of a business refers to its ability to immediately access cash and pay off any debts. Liquidity is usually calculated in terms of a ratio or percentage, with a higher value indicating more liquidity. Several ratios can be used to determine liquidity; the most common calculations include the current ratio and the quick ratio.

Instructions

1. Review your company's balance sheet to determine its current assets. The assets include all tangible and intangible property owned by the company. Make sure the balance sheet is updated and the assets are correctly valued. Take note of the total value of all of your company's assets.

2. Review the company's balance sheet to determine total liabilities. Liabilities include all debts owed by the company, such as loans and expenses. As with the assets, check to ensure the listing of liabilities is up to date. Record the total value of the company's liabilities.

3. Perform the current ratio calculation by dividing the total value of the company's assets by the total value of the company's liabilities. For example, if the assets are valued at $500,000 and the liabilities total $250,000, the current ratio would be 2. Ratios in excess of 1 indicate a high level of liquidity and that the company can easily pay its debts.

4. Calculate the quick ratio, also called the acid-test ratio, by first adding cash and cash equivalents, marketable securities and accounts receivable. Cash and cash equivalents include cash and other assets that can easily be converted into cash, such as Treasury bonds and cashier's checks. Marketable securities are stocks, bonds and other securities that can be easily sold for cash. Accounts receivable is the money owed to your business by its customers. For example, perhaps the total of these assets is $350,000. Divide this number by the total liabilities, which in the example above, was $250,000, to obtain a quick ratio of 1.4.

Tips & Warnings

• The quick ratio is considered more insightful than the current ratio, as it demonstrates the ability of the company to immediately pay down its debt.

References

• "Financial Accounting Fundamentals"; J. Wild; 2009
• "Accounting For Dummies"; John A. Tracy; 2008