Liquidity is the potential to quickly transform an asset into money. If you get bills for electricity, water, and other obligations, how easily and quickly do you get cash to pay them? How long will you be able to pay your bills in case you lose your job or you have a big sudden expense that you have to cover? These are all issues related to personal liquidity.
Similar questions have to be answered by companies – how to pay suppliers and the state, do they have ready reserves in case of problems? Liquidity is also a problem for banks – can they pay off those who withdraw money from their accounts at any time or do they have to obtain it from other banks or the central bank? Keep reading and you will learn everything about liquidity and its ratio.
What Is a Current Ratio Calculator?
The current ratio (general liquidity ratio) is an indicator of a company’s liquidity – the company’s ability to settle its short-term liabilities on time. This ratio provides an answer to the question of whether the company has sufficient funds to meet its short-term liabilities. The current ratio calculator will calculate it for you in less than a second!
The current ratio corresponds to the 2: 1 financing rule, where it measures the company’s current working assets according to current short-term liabilities. Business security companies have a current liquidity ratio above 1. However, this is not entirely acceptable, as a high ratio may be due to high non-current inventories and receivables or high amounts of cash that could possibly be better used for investment. Therefore, this ratio should be analyzed in comparison with functional-territorial aggregates.
Formula
Current Ratio = Current Assets / Current LiabilitiesHere is an example of how to use the formula with the data provided in the table down below:
| Current Assets | 40,000 |
| Current Liabilities | 200,000 |
Current Ratio = 40,000 / 200,000
Current Ratio = 0.2
Why is It Important for a Company to Have a Good General Liquidity Ratio?
Businesses can be profitable, but at the same time, they cannot settle their obligations on time. Many companies do not actually fail because they are not profitable, but because they cannot settle their obligations on time. This is due to a lack of cash. There may be other reasons, for example, when investing during the growth phase of a company, they may run out of cash. Understanding this raid can help identify these financial conditions and ultimately address the lack of working capital.
When a company starts cooperating with a new business partner or monitors existing business partners, one of the basic activities is to check the number of illiquidity days. If the data obtained from this site show that there is a certain number of days of illiquidity paired with the amount for which the account of the business partner or potential partner was blocked, it is a serious signal that cooperation is at risk and that the situation and all other indicators should be considered.
The illiquidity shows that the observed company did not have cash available at a certain moment to settle its due obligations, and therefore the consideration of cash flow is of great importance for the company. The liquidity of the company is of crucial importance because without maintaining liquidity, it is not possible to achieve the ultimate goal of the company – maximizing profits in -the long run.
What Will Reduce Liquidity?
Rising prices of raw materials and energy, as well as rising inflation, have a negative impact on the liquidity of most companies, but there are also those who benefit from this situation. If inflation remains high for a long period of time, it is very likely that interest rates will rise, and thus the company’s operating costs will rise. A possible rise in interest rates would have a negative impact on liquidity, as the debts of the economy have increased significantly over the last few years.
Imagine committing part of your salary for the next 20 or 30 years to giving in the name of a loan. This effectively reduces its liquidity because part of the cash it earns will go to the bank, while in return it has received an apartment that is not very liquid. Many were thus burdened with pre-crisis loans, behaving as if the good times would last forever. With the advent of the recession, many lose their jobs and are left without that inflow of money, and it becomes impossible for them to pay the costs and installments of the loan.
For some, even small expenses such as mobile phone bills have become too much of a burden and have led to a blockade. In any case, the question is not only whether your salary is high enough for the installment, but the real question is whether, even if you pay the loan installment, you can leave something aside just in case to have time to cope in the worst situations.
How to Increase Your Liquidity?
Receivables from sales are current assets of the company. The moment a company sells its receivables based on a sales factor it comes to cash. This means that he can service his obligations on time without additional borrowing.
Companies can pursue the following liquidity policy concepts:
- Full security – high liquidity reserve;
- Limited risk – lower liquidity reserve, attaching importance to liquidity and profitability;
- Full coverage of liabilities – favors profitability in relation to maintaining solvency (no liquid reserve);
- Improvised liquidity – the absence of worries about liquidity and dealing only with the problem of profitability.
The dynamic aspect of improving short-term financial balance and liquidity consists of:
- Determining the number of days of binding certain types of stocks and the possibility of
reducing that number of days;
- Determining the number of days of binding receivables from customers and the possibility of reducing them;
- Determining the number of days of binding received bills and checks and the possibility of increasing the number of days of availability.
How to Manage Personal Liquidity?
Liquidity can be managed by creating reserves, meaning savings, and carefully choosing what you will spend on. It may be better to take away some small joys for a long time so that in case of an accident you are financially ready to withstand the pressure without major consequences. Try to keep track of what you spend, set aside reserves before you start spending on salary, reduce the use of minuses and cards by setting spending limits, and spend reserves on sudden significant expenses.