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Liquidity Ratio Below 1
A business’ liquidity ratio goes to the heart of working capital. Liquidity is a measure of how much cash the business has on hand for immediate use.
A business’ liquidity ratio comes out of the comparison of its Current Assets and Current Liabilities. If the ratio is greater than 1, the business has more current, or liquid assets than current, or payable, debt. If the ratio is less than 1, the opposite applies.
Whilst the liquidity ratio provides a pointer to insolvency, it is by no means conclusive as it is quite possible, although perhaps unusual for a business to be solvent, although having a liquidity ratio that is below 1. A liquidity ratio measures available funds at a specific point in time and does not take into account the dynamics of cashflow. In the final analysis, it is cashflow that must be the final arbiter of insolvency.
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