Types of Liquidity Ratios for Businesses

When running a business, you need various bits of information to guarantee the profitability of your venture. One of the key pieces of information for all types of business is financial ratios. A financial ratio is arrived at by taking a number from your company’s financial reports and dividing it by another. When different values and pieces of information are combined and interpreted together, it will give you a clear picture of your merits or the lack of them for your business and its impact on your operation.

Most people need a tax accountant from West Jordan only when thinking of a company’s financial well-being. However, there are different types of ratios used by accountants to assess your company and advice you accordingly. One of these is the liquidity ratio. This compares your company’s ability to cover debts and other liabilities. If, for instance, you have a few short-term assets to meet your current monetary obligations or you are generating less cash flow than needed for your operation, your business is making losses. The following are the types of liquidity ratios for companies:

Current Ratio

This is designed for the measuring of your company’s short-term insolvency or liquidity. The current ratio is a comparison of your current liabilities and assets. Hence, it measures whether your company has adequate current assets to pay your debts and leave you with an adequate safety margin for potential losses. In general, the ideal current ratio nowadays is 2:1, though the exact one depends on the characteristics of your business.

Quick Ratio

This is also called the acid-test ratio. It measures the relationship between your current liabilities and quick assets. Thus, it determines your ability to repay your debts using quick convertible funds readily. The quick ratio is, therefore, a better ratio than the current ratio as it measures your near cash assets, and not your available inventory. The ideal quick ratio for businesses is 1:1.

Absolute Liquidity Ratio

This is at times called the cash ratio. It measures whether your company can repay all its debts using your marketable securities and bank and cash balances. The cash ratio will not include your debtors and inventory since these have no guarantee of realization.

Net Working Capital Ratio

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This is a basic measure of your cash flow. The net working capital ratio for all businesses should be positive. This is the most common ratio that bankers will keep an eye on to determine whether your business is profitable or whether you are in a financial crisis.

Day Sales Outstanding (DSO)

This denotes the average number of days it will take your business to get paid after making a sale. A high DSO means that it will take too long to get paid for your products, so you are tying your capital up in receivables. DSO is calculated quarterly or half-yearly.

With a good accountant, you can use the types of liquidity ratios to make the right financial decisions. As such, you should get a qualified and knowledgeable accountant to calculate these ratios and help you make sound decisions for your company. Relying on guesswork will only leave you with losses.

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