What is Liquidity?

A profitable business can still fail if it runs out of cash. Liquidity measures whether a business can pay bills, payroll and loan payments as they come due.

Common measures

• Current ratio: current assets ÷ current liabilities. Above 1 means current assets exceed short-term obligations
• Quick ratio: (cash + receivables) ÷ current liabilities, excluding inventory, which may take time to sell
• Cash runway: cash ÷ average monthly net cash outflow
• Working capital: current assets minus current liabilities

What affects liquidity

• Slow-paying customers increase receivables and reduce cash; see accounts receivable aging
• Inventory purchases tie up cash
• Loan principal payments and equipment purchases use cash without affecting profit
• Seasonality creates temporary shortfalls

Liquidity vs solvency

Liquidity is about the short term. Solvency is about whether total assets exceed total liabilities over the long term. A business can be solvent but illiquid, owning valuable equipment but lacking cash for payroll.

Improving liquidity

1. Invoice faster and follow up on overdue accounts
2. Align inventory with demand
3. Negotiate supplier terms
4. Arrange a line of credit before it is needed
5. Avoid funding long-term assets with short-term cash

Protect tax money

Sales tax collected and payroll taxes withheld are not available liquidity; they belong to the government. See the trust fund recovery penalty.

See cash flow basics and financial ratios. The SBA's managing your finances guidance covers cash planning.

Related terms

• Accounts Receivable: Accounts receivable is money customers owe your business for goods or services already delivered.
• Assets: Assets are resources a business owns or controls that are expected to provide future economic benefit.
• Liabilities: Liabilities are amounts a business owes to others, such as suppliers, lenders, employees and tax authorities.
• Working Capital: Working capital is current assets minus current liabilities, the resources available to run day-to-day operations.

Browse more definitions in the small business glossary.