Are you liquid enough? (Current Ratio and Acid Test

Do you know if your business could cover its bills tomorrow if it had to?

Last week, I talked about working capital and its role in funding business growth. The main headline KPI I look at in relation to liquidity is the Current Ratio.

In simple terms, it’s a business’s ability to cover their short term cash requirements (short term creditors, debt repayable within 12 months) from their more-liquid assets (for example, cash, debtors and stock). It’s calculated by taking your current assets figure and dividing by your current liabilities.

Typically, you’re looking for a number greater than 1, and a general benchmark for ‘good’ would be somewhere between 1.5 to 3, but this can differ across sectors and industries.

Another measure to use, taking the current ratio one step further, is the Acid Test. For the acid test, you subtract inventory from your current assets to really get the measure of your liquidity - if your assets are tied up in stock you can’t easily shift then you might have a problem.

If you spot your current ratio or acid test creeping down, assess why. Have you got significant debt repayment due in the next 12 months that a treasury restructure might help with? Are your customers paying on time, and are you happy with credit terms offered and the control you have on credit? Are you comfortable with your stock levels and your ability to shift stock to free up cash?