Quick answer
Liquidity is how easily a business can pay the bills due in the next few weeks and months using cash or assets it can turn into cash quickly. Money in the bank is the most liquid asset, followed by debts customers will soon pay; stock, equipment and property are slower to convert. Lenders check liquidity because a profitable business can still fail if it runs out of cash.
Key points
- Liquidity is about timing: having cash when bills fall due, not just making a profit
- Current ratio and quick ratio are the two standard measures
- Lenders read liquidity straight from your bank statements as well as your balance sheet
- Property is valuable but illiquid, which is why owners borrow against it rather than sell
Picture two businesses with the same profit. One has $60k in its account and customers who pay within a fortnight. The other has $4k in the bank, $150k of stock on the shelves and a big wage run on Thursday. The first is liquid. The second is profitable on paper but could be in real trouble by Friday.
How is liquidity measured?
Two ratios, both pulled from the balance sheet, do most of the work:
| Ratio | Formula | Rough guide |
|---|---|---|
| Current ratio | Current assets ÷ current liabilities | About 1.5 to 2 in most industries |
| Quick ratio (acid test) | (Current assets − stock) ÷ current liabilities | 1.0 or higher |
The quick ratio leaves out stock because selling it fast often means discounting it. When the quick ratio sits well below the current ratio, the business is relying on its shelves to pay its bills. Our working capital ratio calculator runs the first figure for you.
Why do lenders care about liquidity?
A lender wants to know repayments will clear every week or month, not just that the business makes money over a year. Weak liquidity is also one of the earliest warning signs ASIC points directors to, along with overdue tax or super, unpaid suppliers and directors propping the business up with personal money.
In practice, many non-bank lenders judge liquidity from bank statements before they look at a balance sheet. They look for:
- a steady average balance rather than one that hits zero before each payday
- few or no dishonours
- incoming deposits regular enough to cover a new repayment
- existing debts, such as daily merchant cash advance remittances, that drain the account
Liquid and illiquid assets
Assets sit on a spectrum. Cash is fully liquid. Receivables are next, because customers usually pay within weeks. Stock depends on demand. Equipment and vehicles take longer. Real estate is the least liquid of all: a sale can take months and costs agent fees and stamp duty for the buyer.
That gap is why so many owners turn to finance. Invoice finance turns unpaid invoices into cash within days. A caveat loan or second mortgage unlocks property equity without selling the building. If your balance sheet is strong but your bank account isn’t, you can check which option suits you here.
Worked example: a Toowoomba wholesaler
An illustrative farm-supplies wholesaler has current assets of $310k: $25k cash, $95k owed by customers and $190k of stock. Current liabilities are $200k, including supplier accounts and a quarterly BAS.
- Current ratio: $310k ÷ $200k = 1.55, which looks comfortable
- Quick ratio: ($310k − $190k) ÷ $200k = 0.6, which is well short of 1.0
Without selling stock, the business can cover only about 60 cents of each dollar it owes in the short term. A lender would probably suggest a working capital loan or a debtor facility matched to its selling season, not a long fixed loan. Our cash runway calculator shows how many weeks the current balance would last.
Related terms
- Working capital: current assets minus current liabilities, the dollar version of liquidity
- Solvency: the longer-term, legal test of paying debts as they fall due
- Cash flow: the movement of money that liquidity depends on
Short on cash but not on assets?
Plenty of healthy businesses hit a liquidity squeeze because stock, invoices or property hold the value the bank account lacks. Finding the right facility starts with a one-minute form. Your credit score isn’t affected by asking. One person here reviews what you send, then phones to discuss it, and nothing you send is shopped around the market. Give us honest figures for stock, debtors and bills due, and we can point you to the facility that suits how your cash actually moves.
Frequently asked questions
Is liquidity the same as cash flow?
They're closely linked but not identical. Cash flow describes money moving in and out over a period. Liquidity is a snapshot of how much readily available cash and near-cash you hold against what's due soon.
What is a good current ratio?
Queensland's business support site suggests aiming for roughly 1.5 to 2 in most industries, with the quick ratio at 1.0 or better. Supermarkets and cafés often run lower because they're paid in cash daily, while builders and wholesalers usually need more.
Can a business have too much liquidity?
It can. A very high ratio may mean idle cash that could be paying down expensive debt or funding growth, or debtors that are taking too long to pay.
How do lenders check liquidity?
They look at your balance sheet ratios, but many also go straight to three to twelve months of bank statements: average balances, how often the account dips into overdraft and whether any payments have bounced.
How is liquidity different from solvency?
Liquidity is short-term: can you pay this month's bills? Solvency is the legal test of whether a company can pay all its debts as and when they fall due. Poor liquidity left unfixed is often what turns into insolvency.