Current Ratio Calculator

The liquidity ratio is an indicator used to assess whether a company can meet its short-term obligations within one year using the assets that it can convert into cash within the same period. It's among the first ratios lenders, analysts and business managers check when assessing a company's short-term financial health.

This tool calculates the liquidity ratio from liquid assets and current liabilities and also supports calculations in reverse. If you enter a value for either of these two ratios, then it can determine the value of the other.

What does the liquidity ratio measure?

The liquidity ratio compares a company's liquid assets to its short-term liabilities. Liquid assets include cash, accounts receivable, inventory, prepaid expenses and other assets that can be converted into cash within one year. Short-term liabilities are debts due within the same time period, such as accounts payable, short-term loans, accrued expenses and the current portion of long-term debt.

If a company has $500,000 in current assets and $250,000 in current liabilities, the liquidity ratio is 2.0. This means that there are two dollars of short-term assets to cover every dollar of short-term debt, which would normally be expressed as 2:1.

How to calculate liquidity ratio using a balance sheet:

To calculate your liquidity ratio using a balance sheet, you only need two totals.

1. Total current assets: cash and cash equivalents, securities, receivables from supplies and services, inventories, prepayments.

2. Total short-term liabilities: Liabilities from deliveries and services, wages and taxes still to be paid, short-term loans, the term-dependent part of long-term debts.

3. Divide your assets by your liabilities. This is your liquidity ratio.

You can determine the value of any side.

The formula only shows a relationship between three values. So the formula can be rearranged to calculate for any missing value. Leave the appropriate column blank and enter the other two values.

This is useful for practice problems in textbooks or for planning purposes. If you know the required ratios and debt amounts of a loan agreement, this tool can calculate the required value of assets.

A full example:

Suppose a company has $840,000 in current assets and $480,000 in current liabilities.

Thus, the company's liquidity ratio is 1.75 and its working capital is $360,000. This means that for every dollar of short-term liabilities there are $1.75 in liquid assets available to cover it. The table below shows the values for this example and explains each term.

What is a good liquidity ratio?

In most industries a ratio between 1.5 and 3.0 is considered relatively stable, but the appropriate value depends heavily on the actual business activities of the company. Banks generally prefer a ratio just over 1, while some managers like to have a larger buffer of at least 2:1 because of seasonal fluctuations or unexpected expenses.

A single value doesn't tell you much. A liquidity ratio of 1.2 might be a cause for concern in a utility company but could be perfectly normal for a grocery store chain. More important than individual values for a particular quarter are trends. If the ratio is gradually decreasing from 2.0 to 1.1 over four quarters, that's a stronger signal than an individual quarter with a value of 1.1.

Liquidity ratio, quick turnover ratio and cash ratio

The liquidity ratio assumes that all current assets are equally liquid, which is not always the case in reality. Inventories may be difficult to sell and prepayments do not represent actual cash. The quick ratio (also called the acid test ratio) excludes these items for a more stringent measure. The cash ratio is even stricter and only considers cash and cash equivalents. If you open the details of liquidity in this tool, you can see all three ratios at once.

Working capital

The working capital is the difference between short-term assets and liabilities. While liquidity ratio shows liquidity as a proportion, working capital is measured in absolute numbers. So it represents the financial cushion that remains after paying off short-term debts. A positive number indicates that short-term assets are superior to short-term obligations while a negative number means the opposite.

Use of liquidity ratio

The lender will examine this value as part of the credit application process. Even if other financial data looks good, a value below 1.0 can result in the loan being denied. Managers consider this value along with the current ratio and liquidity ratio when deciding how much inventory to hold, what payment terms to set or whether to take out a line of credit. Checking once per month or at least quarterly allows you to spot warning signs early enough that there is still time to take action.

How to improve a low liquidity ratio

Actions to increase short-term assets or reduce short-term liabilities are equally helpful. Common strategies include collecting receivables more quickly, speeding up inventory turnover, converting short-term debt into long-term debt, and selling idle assets to pay off obligations with near-due dates. The goal is to do this without jeopardizing future earnings.