Last updated: 25th Aug 2025
Not being able to pay your business’ bills on time is a bad look. You’ll lose credibility with vendors. Your credit score will suffer. How do you prevent this? You start by knowing your liquidity ratios.
A recent review by the Reserve Bank of Australia has identified “an extended period of cashflow difficulty, leading to an inability to repay debts” as a common denominator behind company insolvencies.
Yes, times are tough for business.
But the RBA notes that:
The good news? You can tackle underlying issues that steer your business towards a cash flow crisis.
Above: Inadequate cash flow is the #1 killer of Australian businesses.
What Is A Liquidity Ratio?
A liquidity ratio helps you understand your ability to cover your business’ debts in the short-term, using cash and other liquid assets on hand.
If you’ve got more liquid assets than payments due in the coming year, that’s a healthy sign for your cashflow.
- Liquidity refers to how easily you can convert assets into cash to meet your business’ day-to-day expenses. For instance, in addition to the money in your business’ transaction and savings accounts, you might hold a stock portfolio that could be sold quickly to access money.
- Staying solvent long-term can be impacted by ongoing cashflow issues. If you’re regularly struggling to manage daily expenses, your growth will stall, you may be forced to sell fixed assets, and it puts you at risk of insolvency, business closure or bankruptcy.
Liquidity Ratio Calculation Example:
Provided you’re using accounting tools to accurately record your assets, income, payroll, inventory, and accounts payable/receivable, you should be able to trust the current assets and current liabilities amounts listed on your balance sheet report.
- Current assets can include cash, bank deposits, money owed to you, stock on hand, raw materials, and short-term investments.
- Current liabilities can include bills, employee wages, supplier invoices you need to pay, taxes and loan payments.
Important!
Your business may also have a range of fixed assets (equipment, vehicles, buildings) that aren’t factored in, because they can’t efficiently be traded for cash as needed.
(Related: The Best Accounting Software For Small Businesses In 2025.)
What Is A Good Liquidity Ratio?
In the case that your liabilities are matched exactly by your assets, it’s a 1:1 relationship.
A liquidity ratio above 1 reflects that your available assets exceed your financial obligations, which makes it more likely you’ll be able to handle your known operational expenses.
If your liquidity ratio is below 1, it shows you could be caught short and miss payments. Unless you can find emergency cash or negotiate terms, you risk seriously damaging your relationships with vendors or employees, or potentially running up further costs from penalties, fines or interest.
(Related: How To Calculate And Improve Your Net Profit Margin.)
If it’s a momentary blip, that’s one thing. It’s quite another if your ratio is regularly below 1, because it means you literally can’t afford to stay in business.
Important!
Poor bookkeeping and not being able to analyse your finances is a major contributor to insolvencies. No visibility leads to careless decision-making or overspending that eats into your profits and cash reserves.
Types Of Liquidity Ratios.
There are three main ways to calculate a liquidity ratio. The calculations differ based on what you include in ‘current assets’.
- Current ratio: calculates the ratio using all of your current assets.
- Quick ratio (aka acid-test ratio): excludes inventory from your current assets to determine the ratio.
- Cash ratio: excludes everything except cash (and cash equivalents like money market fund, stocks, short-term bonds).
Current ratio is the broadest, and easiest calculation. But knowing your assets-to-liabilities ratio in the context of a narrower set of assets can be useful. Because not all assets are equal in terms of their liquidity.
Think worst-case scenario. Let’s say you get an illness that puts you out of action long-term, or another global pandemic hits and the demand for all the products sitting in your warehouse dries up overnight — would you still be able to access enough money to pay your bills?
If your current ratio looks healthy, but your quick ratio falls below 1, you might be too reliant on future sales that may not eventuate.
Liquidity Quick Ratio Calculation Example:
Why Does Your Liquidity Ratio Matter?
With ongoing price inflation, reasonably high interest rates (although easing), and a somewhat rocky global economic outlook, SMBs need to be prepared in case of downturns in demand. Small cash reserves can be quickly depleted if anything goes wrong.
Did you know?
Almost 90% of small businesses surveyed by the NSW Small Business Commissioner in June said they were concerned about the cost of business inputs, and just 20% felt confidence about their individual business prospects.
A recent survey of over 700 Australian small-to-medium enterprises with revenues of between $1-$20 million found that one in five businesses believe the loss of just one key client or supplier would tip their business into failure. Over 75% said they’d lose an average of around 22% in revenues if a major client departed.
Also, a higher liquidity ratio is one of the indicators of financial health that will put you in a better position to secure a business loan or secure investment.
- Creditors will analyse your liquidity ratio as part of a loan application to determine if you’ll be able to manage the repayments.
- Investors will use the metric as a guide to whether your business has long-term viability, including enough working capital to grow.
(Related: The Ultimate Guide To CapEx For SMBs.)
How To Improve Your Liquidity.
Here are some tips for improving liquidity in your SMB:
- Free up cash flow where you can, such as by cutting back on wasteful expenditure like subscriptions or software you don’t use often, or perhaps hiring freelancers on a project basis rather than a full-time employee, or selling a company vehicle you don’t need.
- Open a high interest savings account for your business and get intentional about setting aside a portion of income regularly. It’s smart to build a savings habit so you’ve always got cash reserves for tax bills, investment opportunities, and emergencies.
- Aim for a leaner, just-in-time approach to purchasing and be strategic the products you keep in stock. It may make sense to hold large quantities of fast-moving goods with historically high levels of demand, but too much slow-moving stock can unnecessarily tie up cash.
- Negotiate your contract and payment terms to help you balance the need to collect promptly on what you’re owed by clients/customers to have cash flowing in, and not be beholden to unrealistic turnaround times for paying your suppliers or bills.
- Carefully manage debts. Think twice about using credit cards instead of cash for payments, and make sure you’re making card repayments on time to avoid interest costs. If you take out a loan, choose a repayment timeframe that ensures the size of repayments is manageable.
Improving your liquidity will reduce your stress, but it’s also critical to being able to jump on business opportunities as they arise. For example, being able to fund the development or purchase of new product lines, or run marketing campaigns that extend your market share and long-term success.
Jody
