How to Calculate Sufficient Liquidity

Consult your accountant if the assets and liabilities aren't at hand.

Liquidity is the ability of a business to pay cash and pay its bills and debts at all times. Sufficient liquidity leaves some cushion room in the event that some of the incoming invoices or debts owed the business take longer than expected or default. To calculate the level of sufficient liquidity in a company, the quick ratio formula is applied. Quick ratio is also known as acid test ratio, liquid ratio or liquidity ratio.

Things You'll Need

• Balance sheet

Instructions

1. Tally the assets that can be directly translated into cash such as cash in the bank, investments and bills payable to the company. Inventory and prepaid expenses are not included in this number as they do not translate into instant cash without additional loss.

2. List the liabilities including, but not limited to, debts, bills due, income tax and dividends due to investors.

3. Take the total liquid assets and divide them by the total liability. The result will be the quick ratio. Ratios higher than 1 indicate sufficient liquidity in most instances. Compare the ratio rating to similar competing companies for a fair analysis.

4. Calculate the quick ratio monthly or quarterly to record trends in the company’s liquidity throughout the year. Sufficient liquidity will mean the business will have the means to acquire cash to pay its bills whenever they come due.

References

• Entrepreneur; 7 Ways to Improve Liquidity; Pam Newman
• AccountingforManagement.com: Liquid Ratio
• Mercury Webster: Financial Ratios