How Liquid Are You?

Posted on August 5 · Comments

Some of the accounting ratios can be useful in everyday personal finance. The current ratio and the liquid ratio are two ratios that let you asses how far over your head you are in debt. You can assess your financial health at a glance and use the ratio to track your progress back into the black.

Liquidity is about how cashed up you are and whether you can easily make repayments on debt.

Before you can calculate your liquid ratios, you need to have a statement of net worth.

The current ratio. It is calculated by dividing the total value of your assets by the total value of your liabilities. This is then written as a ratio to 1.

So if the value of your assets are equal to the value of your debts, the your ratio would be 1:1. If your creditors demanded that you had to pay all of your debts today, then you would be able to cover them, but would be left with nothing. If your ratio is 2:1 then you can cover your debts 2 times over. If the ratio is less than 1 like 0.5:1 then you don’t have enough value in your assets to cover your debts.

If you look at the statement of net worth, the total value of assets is $243,500 and the total value of liabilities is $80,050. This makes the current ratio 3.04:1 – debts can be covered three times over by the value of the assets.

The liquid ratio is similar, but it only looks at liquid assets and short term loans. Liquid assets are those that are cash or can be readily turned into cash – so savings, shares, managed funds, bonds. And short term loans usually include credit card balances, personal loans, etc. – debts where there is no distinct asset attached to them like a car loan.

The liquid ratio measures whether you can pay short term loans in whole when they fall due. It is considered a better measure of financial health. Improving your liquid ratio provides a buffer against bad times.

The liquid ratio is calculated in the same way as the current ratio and is shown as ratio to 1. So if your liquid ratio is 3:1 then you have enough ready cash to cover your short term debts 3 times over.

There are two ways to improve your liquid position. Increase you savings, or reduce your debt (or both). Watching the change in your current and liquid ratios is another motivator when you’re trying to get out of debt. Use it as a tool along side tracking your cash flow with your budget.