When seeking financing for your business, there are certain metrics you’ll need to know. Liquidity ratio, for instance, is an important metric. Many lenders will consider your business’s liquidity ratio. With a good liquidity ratio, you’ll have an easier time getting approved for financing. What is liquidity ratio in accounting exactly, and how do you calculate it?
The Basics of Liquidity Ratio
Liquidity ratio is a measurement of your business’s assets relative to its liabilities. Assets are items of monetary value. There are tangible assets, and there are intangible assets. Regardless, they are all items of monetary value that your business owns.
Liabilities, on the other hand, are financial obligations. Any debt that your business owes to a lender, organization or individual is a liability. Liabilities are essentially the opposite of assets. Assets represent value, whereas liabilities represent debt. With liquidity ratio, you can compare your business’s assets to its debt.
Calculating Your Business’s Liquidity Ratio
As long as you know your business’s assets and liabilities, you can calculate its liquidity ratio. There are several different formulas available for liquidity ratio. The simplest formula involves taking your business’s assets and dividing it by your business’s liabilities.
There are other formulas you can use to calculate liquidity ratio, but they all require knowing your business’s assets and liabilities. Assets and liabilities are the foundation of liquidity ratio. With this information, you can determine the correct liquidity ratio for your business.
What Liquidity Ratio Reveals About Your Business
Liquidity ratio lives up to its namesake by revealing your business’s liquidity. In other words, it’s a measurement of how easily your business can pay its debts.
Nearly all businesses have debt. Research shows that most small businesses have about $10,000 of debt. Larger businesses often have over $100,000 of debt. As your business takes on debt, though, you’ll need to ensure that you’re able to repay it.
You can use liquidity ratio to determine the ease at which your business can satisfy its financial obligations and, thus, repay its debt. A high liquidity ratio will give you peace of mind knowing that your business can repay its debt. It means your business has a lot of assets relative to its debt. And you can probably use some of its assets to pay down the debt.
Lenders may also look at your business’s liquidity ratio. Since it’s a measurement of how easily your business can repay its debt, many lenders will take into account liquidity ratio when determining whether to approve your business for financing.
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