Liquidity - How to Measure Working Capital in Your Business

Liquidity - How to Measure Working Capital in Your Business
Ronis Gracie
on March 22, 2020
Read in 1 min

Liquidity comes into play when an otherwise profitable business runs into cash-flow problems.

Even with high sales, it’s possible for a company to be asset rich and cash poor.

While the numbers on the books may look strong, waiting around for customers to pay can result in a cash-flow crisis.

It is a fact of life and a common struggle for small business owners:

Some clients will pay late.

Worse yet, others will not pay at all!

Measuring the liquidity of your business will be useful for you in finding a way to weather these conditions and avoid cash shortages.

There are two measures of liquidity in commonly practice:

Working Capital

One measure is Working Capital. It’s the difference between the Current Assets and the Current Liabilities as seen below:

Working Capital = Current Assets – Current Liabilities

In general, assets are something that a business owns.

Current Assets are items that can be cashed relatively quickly (without a fire sale) or that will turn into cash within a year or less.

Examples include cash, short-term investments (such as Money Market funds, certificates of deposit, treasury bills), inventory, and accounts receivable.

On the other hand, liabilities are what a business owes.

When it comes to Current Liabilities, these include accounts payable, accrued expenses, taxes payable, payments on a loan, and wages.

What is current differs among companies, but accountants usually consider items of one year or less to be current.

If there’s a positive Working Capital, then the signs are that things are going okay.

Usually, the bigger the surplus, the better. On the other hand, a negative Working Capital, or just a small surplus, may mean trouble is coming.

Quick Ratio (aka Acid-Test Ratio)

Quick Ratio is another measure of your liquidity.

It indicates how capable the business is when it comes to covering Current Liabilities with Current Assets.

The formula to calculate it is as follows:

Quick Ratio = (Current Assets – Inventory) / Current Liabilities

Most accountants consider a Quick Ratio of over 1 to be a measure of good liquidity.

Although, it may differ among businesses, staying above 1 means you’re pretty liquid at the time of the measure.

Inventory is omitted from the Quick Ratio equation because it rarely qualifies as a liquid asset.

Not to mention certain types of inventory may decay, become obsolete, or even get stolen.

These measures can change over time, so evaluate Working Capital and Quick Ratio every month or so to stay on top of your liquidity.

It is equally important to measure these ratios properly.

Estimates of your current assets and liabilities need to be as precise as possible.

See Business Lenders
Ronis Gracie Finance Journalist

A serial entrepreneur experienced with building several small companies from the ground up and consulting for many others, Ronis understands the finer points of small business financing. He’s passionate about small business & is committed to simplifying small business lending for others.

Important Disclosures. Please Read Carefully.

Persons facing serious financial difficulties should consider other alternatives or should seek out professional financial advice. This website is not an offer to lend. Lendgenius.com is not a lender or lending partner and does not make loan or credit decisions. Lendgenius.com connects interested persons with a lender or lending partner from its network of approved lenders and lending partners. Lendgenius.com does not control and is not responsible for the actions or inactions of any lender or lending partner, is not an agent, representative or broker of any lender or lending partner, and does not endorse any lender or lending partner. Lendgenius.com receives compensation from its lenders and lending partners, often based on a ping-tree model similar to Google AdWords where the highest available bidder is connected to the consumer. Regardless, Lendgenius.com’s service is always free to you. This service is not available in all states. If you request to connect with a lender or lending partner in a particular state where such loans are prohibited, or in a location where Lendgenius.com does not have an available lender or lending partner, you will not be connected to a lender or lending partner. You are urged to read and understand the terms of any loan offered by any lender or lending partner, and to reject any particular loan offer that you cannot afford to repay or that includes terms that are not acceptable to you. By submitting your information via this website, you are authorizing Lendgenius.com and/or lenders and lending partners in its network or other intermediaries to do a credit check, which may include verifying your social security number, driver license number or other identification, and a review of your creditworthiness. Credit checks are usually performed by one of the major credit bureaus such as Experian, Equifax and Trans Union, but also may include alternative credit bureaus such as Teletrack, DP Bureau or others. You also authorize Lendgenius.com to share your information and credit history with its network of approved lenders and lending partners. For qualified consumers, our lenders offer loans with an Annual Percentage Rate (APR) of 35.99% and below. For qualified consumers, the maximum APR (including the interest rates plus fees and other costs) is 35.99%. All loans are subject to the lender’s approval based on its own unique underwriting criteria. Example: Loan Amount: $4,300.00, Annual Percentage Rate: 35.99%. Number of Monthly Payments: 30. Monthly Payment Amount: $219.36. Total Amount Payable: $6,581.78 Loans include a minimum repayment plan of 12 months and a maximum repayment plan of 30 months. In some cases, you may be given the option of obtaining a loan from a tribal lender. Tribal lenders are subject to tribal and certain federal laws while being immune from state law including usury caps. If you are connected to a tribal lender, please understand that the tribal lender’s rates and fees may be higher than state-licensed lenders. Additionally, tribal lenders may require you to agree to resolve any disputes in a tribal jurisdiction. You are urged to read and understand the terms of any loan offered by any lender, whether tribal or state-licensed, and to reject any particular loan offer that you cannot afford to repay or that includes terms that are not acceptable to you.

Lender’s or Lending Partner’s Disclosure of Terms.

The lenders and lending partners you are connected to will provide documents that contain all fees and rate information pertaining to the loan being offered, including any potential fees for late-payments and the rules under which you may be allowed (if permitted by applicable law) to refinance, renew or rollover your loan. Loan fees and interest rates are determined solely by the lender or lending partner based on the lender’s or lending partner’s internal policies, underwriting criteria and applicable law. Lendgenius.com has no knowledge of or control over the loan terms offered by a lender and lending partner. You are urged to read and understand the terms of any loan offered by any lenders and lending partners and to reject any particular loan offer that you cannot afford to repay or that includes terms that are not acceptable to you.

Late Payments Hurt Your Credit Score

Please be aware that missing a payment or making a late payment can negatively impact your credit score. To protect yourself and your credit history, make sure you only accept loan terms that you can afford to repay. If you cannot make a payment on time, you should contact your lenders and lending partners immediately and discuss how to handle late payments.