What is liquidity?
Liquidity has two related meanings:
- Asset liquidity: how quickly an asset can be turned into cash without losing value. Cash is the most liquid; property and specialised machinery are among the least.
- Business liquidity: whether a company has enough liquid resources to pay bills as they fall due.
Liquidity ratios
- [Current ratio](/glossary/current-ratio) = Current assets ÷ Current liabilities
- [Quick ratio](/glossary/quick-ratio) = (Cash + Receivables + Short-term investments) ÷ Current liabilities
- Cash ratio = Cash and equivalents ÷ Current liabilities
Liquidity vs solvency vs profitability
- Liquidity: can we pay what's due soon?
- [Solvency](/glossary/solvency): can we meet all long-term obligations?
- Profitability: are we earning more than we spend?
A profitable business can still fail if it runs out of liquid cash.
Signs of liquidity problems
- Regularly paying suppliers late
- Relying on overdrafts for routine costs
- Growing [accounts receivable](/glossary/accounts-receivable) and slow collections
- Too much cash tied up in inventory
How to improve liquidity
- Speed up invoicing and collections.
- Negotiate longer supplier terms.
- Reduce excess stock.
- Arrange a [line of credit](/glossary/line-of-credit) before you need it.
- Forecast cash weekly.