The 10 Most Important Liquidity Ratios at a Glance
- 3 days ago
- 10 min read
CFOs must know at all times whether their company is solvent, how long existing liquidity will last and which risks arise from receivables, liabilities, cash flows and forecast deviations. Liquidity ratios make this solvency measurable.
Especially in mid-sized companies, classic liquidity ratios are not enough because they are often only based on a reporting date. Dynamic ratios that reflect cash flows, capital tied up and planning quality are essential.
What Are Liquidity Ratios?
Liquidity ratios allow companies to compare available liquid funds, receivables, current assets or cash flow with current liabilities and payment outflows.
There are two categories of ratios:
Static liquidity ratios: Balance sheet-based and related to one exact point in time
Dynamic liquidity ratios: Cash flow-based and related to a defined period
In short: liquidity = solvency, liquidity ratios = measurable solvency
Why Are Liquidity Ratios Important for CFOs?
In medium-sized companies, decisions that affect the entire business are part of everyday life. Liquidity ratios often provide the basis for these decisions.
But their value extends beyond the company itself: banks and investors rely on the same figures. Anyone seeking or negotiating capital is judged by them. For CFOs, liquidity ratios are therefore far more than just an internal control tool: those who understand them thoroughly are in a stronger position.
The 10 Most Important Liquidity Ratios at a Glance
We have summarised the 10 most important liquidity ratios for mid-sized companies:
No | Ratio | Formula | Meaning |
1 | 1st degree liquidity | Liquid funds / current liabilities × 100 | Shows which share of current liabilities can be paid immediately |
2 | 2nd Degree liquidity | (Liquid funds + short-term receivables) / current liabilities × 100 | Shows short-term solvency including expected incoming payments |
3 | 3rd degree liquidity | Current assets / current liabilities × 100 | Shows whether current liabilities are covered by current assets |
4 | Net working capital | Current assets - current liabilities | Shows short-term financial flexibility |
5 | Operating Cash flow Ratio | Operating cash flow / current liabilities | Shows whether liabilities can be serviced from operating cash flow |
6 | Cash Conversion Cycle | DIO + DSO - DPO | Shows how long capital is tied up in the operating cycle |
7 | Receivables collection period / DSO | Receivables / revenue × days | Shows how long customers take on average to pay |
8 | Payables payment period / DPO | Payables / cost of goods sold × days | Shows how long the company takes on average to pay suppliers |
9 | Liquidity runway | Available liquidity / average net cash outflow | Shows how long existing liquidity will last |
10 | Forecast Accuracy | 1 - absolute forecast deviation / actual value | Shows how reliable liquidity planning is |
1st Degree Liquidity: Cash Liquidity
1st degree liquidity shows which share of current liabilities is immediately covered by available liquid funds. It is also called cash liquidity or cash ratio.
Formula and Calculation
Cash liquidity = Liquid funds / current liabilities x 100
Liquid funds include:
Bank balances
Cash on hand
Assets that can be converted into cash within a short time
For example:
A company has €100,000 in liquid funds and €500,000 in current liabilities.
€100,000 / €500,000 x 100 = 20%
This means that the company can immediately settle 20% of its current liabilities from liquid funds.
Benchmark, Interpretation and Limits
Benchmarks vary depending on market, country and industry. In general, cash liquidity between 10 and 30% is recommended as a guide.
With a value of 10%, a company could immediately pay 10% of its current liabilities.
However, the ratio also has some limits:
Very strict: It only counts immediately available money. A full value would be unrealistic, as hardly any company can, or should, cover all debts in cash.
Ignores receivables: Money that will come in from customers in a few days is not counted.
Low value does not mean critical if secure incoming payments are expected shortly.
Very high value: Can mean that too much capital is sitting unused in accounts.
For CFOs, liquidity 1st degree is mainly relevant as a short-term safety indicator. It is not used as the only measure of financial stability.
2nd Degree Liquidity: Quick Ratio
2nd degree liquidity, or quick ratio, shows whether current liabilities are covered by liquid funds and short-term receivables. Unlike cash liquidity, short-term receivables are also considered here.
Formula and Calculation
2nd degree liquidity = (Liquid funds + short-term receivables) / current liabilities x 100
Example:
A company’s financial position looks as follows:
Liquid funds: €100,000
Short-term receivables: €400,000
Current liabilities: €500,000
Calculation: (€100,000 + €400,000) / €500,000 x 100 = 100%
This means that the company could settle its current liabilities within a short time using liquid funds and expected incoming customer payments.
Benchmark, Interpretation and Limits
Here too, there is no universal benchmark. Every industry and company is different.
A value of 100% shows mathematically that current liabilities are covered by liquid funds and short-term receivables. However, actual solvency depends on whether receivables are paid on time.
A value significantly above 100% may indicate a conservative liquidity policy or unused capital, but it must be assessed depending on industry and risk situation.
However, with 2nd degree liquidity, it must be noted that receivables are only helpful and reliable if customers also pay on time. Payment defaults or late incoming payments can worsen actual liquidity.
The ratio should therefore not be viewed in isolation, but always together with the receivables collection period. A good value can be misleading if collection periods are increasing.
3rd Degree Liquidity: Current Ratio
3rd degree liquidity shows whether current liabilities are covered by total current assets. It considers liquid funds, short-term receivables and inventories together. It is also called the current ratio.
Formula and Calculation
3rd degree liquidity = (Current assets / current liabilities) x 100
Current assets include:
liquid funds
short-term receivables
Inventories
other short-term assets
Here is an example:
A company has:
Current liabilities of €500,000
Current assets of €800,000
Liquidity 3rd degree: €800,000 / €500,000 x 100 = 160%
This means that current liabilities are fully covered and there is even a buffer.
Benchmark, Interpretation and Limits
A healthy guide value is around 150 to 200%. Traditionally, the 2:1 rule, or 200%, is recommended. This means that for every euro the company owes in the short term, it has €2 in short-term available assets.
If the value is below 100%, current liabilities exceed current assets. This can be a warning signal because short-term obligations are not fully covered by short-term assets.
Like the other ratios, liquidity 3rd degree is also highly industry-dependent. Retail and industry, with many inventories, have very different normal values from service providers. A general comparison has little meaning.
But this liquidity ratio should also be viewed with caution:
Inventories are often not quickly liquidated.
Reporting-date view: It is based on a single point in time.
A high value is not automatically better: It can mean that too much capital is tied up and used inefficiently.
Quality is left out: Outdated inventories or doubtful receivables are not considered.
4. Net Working Capital
Net working capital shows a company’s short-term financing flexibility. It shows which part of current assets remains for financing operating business after deducting current liabilities. For many CFOs, it is one of the most important ratios.
Formula and Calculation
Net working capital = Current assets - current liabilities
For example:
A company has:
Current assets of €800,000
Current liabilities: €500,000
Net working capital = €800,000 - €500,000 = €300,000
As the value is positive, it means that short-term assets are higher than current liabilities.
Industry-Specific Characteristics
Because this ratio is expressed as an absolute euro value instead of as a percentage, it is harder to define a benchmark than with other ratios.
Across industries, net working capital must be assessed differently depending on the business model.
For example:
Retail companies often have high inventories.
Production companies have capital tied up in materials, semi-finished goods and finished goods.
Service providers often have fewer inventories, but high receivables.
However, as with many liquidity figures, a high value is not automatically positive. CFOs should therefore ensure that not too much capital is tied up in inventories or receivables.
Operating Cash Flow Ratio
The operating cash flow ratio shows the extent to which a company can service its current liabilities from operating cash flow. At first glance, it may seem similar to net working capital. However, the operating cash flow ratio is a dynamic liquidity ratio.
The formula is:
Operating Cash Flow Ratio = Operating cash flow / current liabilities
It shows how much money actually flows in from ongoing business.
Here, the higher the value, the better the company can finance short-term obligations from ongoing business.
With the operating cash flow ratio, the following must be considered:
The ratio depends on the period being analysed.
A one-off strong or weak cash flow can distort the picture.
Seasonal companies need to look at several periods.
For CFOs, this ratio is especially important because it shows whether their business model actually generates capital or whether liquidity only appears stable through financing, credit lines or payment deferrals.
Cash Conversion Cycle
The cash conversion cycle, or CCC, shows how long capital is tied up in the operating business process. From purchasing, storage and sale to the receipt of payment from the customer. It measures the period, in days, that a company needs to convert goods back into liquid funds and is therefore also called the cash turnover period.
Formula and Calculation
Cash Conversion Cycle = DIO + DSO - DPO
DIO = Days Inventory Outstanding or inventory period.
DSO = Days Sales Outstanding or receivables collection period.
DPO = Days Payable Outstanding or payables payment period.
A shorter cash conversion cycle means that capital is converted back into liquidity faster.
Optimisation Approaches for the CCC
CFOs can work specifically on improving the CCC by:
Reducing inventories
Improving receivables management
Shortening payment terms with customers
Optimising payment terms with suppliers
Planning payment flows better
Regularly updating forecasts
However, not every reduction makes sense. Inventories that are too low can put delivery capability at risk, and payment terms that are too long can put relationships under pressure.
Receivables Collection Period / DSO
The accounts receivables collection period, also often called Days Sales Outstanding, shows how many days customers need on average to pay invoices.
The formula is:
DSO = Trade receivables / revenue x number of days
The DSO could look as follows, for example:
Receivables: €300,000
Revenue in the period: €900,000
Period: 90 days
DSO = €300,000 / €900,000 x 90 = 30 days
A low DSO means that customers pay quickly. A rising DSO can often indicate late incoming payments, weak dunning processes or unfavourable payment terms.
CFOs should pay attention to DSO because receivables are recorded on the balance sheet, but only create real liquidity when payment is received.
Payables Payment Period / DPO
The payables payment period, also called Days payable Outstanding, shows how many days a company needs on average to pay supplier invoices.
The formula is:
DPO = Trade payables / cost of goods sold x number of days
A higher DPO can protect liquidity in the short term because payments flow out later and can therefore be better aligned with incoming payments. However, a DPO that is too high can put supplier relationships under pressure, cost cash discount benefits and be counterproductive in the long term.
CFOs must actively manage DPO: paying too early puts pressure on liquidity, while paying too late can endanger trust and delivery capability.
DPO is part of the cash conversion cycle. The higher the DPO, the shorter the cash conversion cycle can become mathematically.
Liquidity Range
The liquidity range shows how long a company remains solvent with the currently available liquidity if average net cash outflows remain unchanged.
The ratio is expressed as a period of time and calculated using the following formula:
Liquidity runway = available liquidity / average net cash outflow per period
For example:
A company has:
Available liquidity of €600,000
An average monthly net cash outflow of €200,000
€600,000 / €200,000 = 3
This means that the company has a liquidity runway of 3 months.
The higher the liquidity runway, the longer a company can bridge financial burdens, revenue declines or delayed incoming payments.
The liquidity runway is a very practical ratio. It directly answers: “How long will our cash last?” and is very suitable for scenario planning and early warning systems.
Forecast Accuracy
Forecast accuracy means the precision of forecasts, but it is more commonly used under the English term. The ratio measures how accurate liquidity forecasts were compared with actual payment flows.
The formula is:
Forecast Accuracy = 1 - (forecast - actual value) / actual value
Example calculation:
Planned net cash flow: €500,000
Actual net cash flow: €450,000
Deviation: €50,000
Forecast Accuracy = 1 - €50,000 / €450,000 = 88.9%
The closer the value is to 100%, the more accurate the forecast was. Low forecast accuracy shows that assumptions, data quality or planning processes need to be improved.
Forecast accuracy is not a classic liquidity ratio, but it is extremely important for modern liquidity management. It shows whether CFOs can trust their own planning.
Modern Treasury Management Solutions can help connect actual data and forecasts centrally, make deviations visible and continuously improve liquidity forecasts. Book a demo.
Interpreting Liquidity Ratios Correctly: Benchmarks and Typical Mistakes
Given benchmarks only serve as guidance and should not be used as fixed target values. Liquidity is highly dynamic and depends on industry and business model, and the same applies to liquidity ratios.
Typical mistakes that mid-sized companies often make when interpreting liquidity ratios are:
Treating receivables like cash
Building high inventories to improve liquidity 3rd degree, although these are not automatically liquidated in the short term.
Individual ratios are assessed in isolation.
High liquidity is always interpreted as positive, although it can also mean inefficient capital tied up.
How a Treasury Management System Automates Liquidity Ratios
Modern Treasury Management Software allows liquidity planning and payment flows to be managed through one central platform. It makes the work easier for finance teams because they no longer have to work with many Excel lists and several bank portals, but can use one platform. Liquidity ratios can be updated and calculated automatically. This reduces manual work and the risk of errors.
Real-Time Transparency Instead of Reporting-Date Analysis
Financial Navigator supports mid-sized finance teams in monitoring liquidity ratios centrally, automatically and more up to date. The biggest advantage here is that the ratios are not only calculated automatically, but also updated in real time.
This allows CFOs to have real-time transparency over the company’s actual liquidity instead of relying on outdated reporting-date analyses.
Automated Liquidity Forecasts With Financial Navigator
Financial Navigator makes AI-supported forecasts accessible for mid-sized companies.
Manual work can be reduced and finance teams can experience several benefits within a few weeks:
Direct connection between actual data and forecasts
Clear visibility of deviations
Improvement of forecast accuracy
Scenario analyses for potential bottlenecks
Modern alternatives to heavy ERP processes
With more than 13,000 bank connections and more than 30 active countries, Financial Navigator can create an important basis for more transparent liquidity planning and more reliable ratios.
Conclusion: Liquidity Ratios as a Management Tool in Financial Management
Liquidity ratios are not a “nice extra” in liquidity planning, but essential for CFOs. They often form the basis for many decisions and are the measure by which a company presents itself externally. However, they only deliver real value if they are current and interpreted correctly.
Classic liquidity ratios are important, but not enough. Only the combination with dynamic ratios on cash flow, working capital and forecasts creates a complete picture.
Financial Navigator supports mid-sized companies with modern liquidity management and easy implementation.
Book a demo and discover modern treasury management.