Accounting Glossary

What Is Liquidity?


Liquidity (Definition)

Liquidity measures a business’s ability to pay all its bills and loans in the coming months. It is commonly expressed as a ratio.

Liquidity compares current liabilities (which are amounts owed within the coming 12 months) against current assets. Current assets include cash the business has, plus payments due to come in, and any assets that could be sold quickly.

What Liquidity Means For The Business

A ratio of one or more shows the business can cover its costs and is generally in good shape. A ratio of less than one is not so positive but isn’t necessarily a bad thing. A business that’s investing in growth will have bigger bills and may find its current ratio drops below one. However, most businesses will want to avoid having a ratio that is permanently stuck at less than one.

The liquidity ratio will change depending on where a business is in its billing cycle, so it’s a good idea to measure it at the same time every month. That way you’re comparing like for like and can see if liquidity is trending up or down over the long term.

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