Liquidity Ratio

What is a liquidity ratio?

A liquidity ratio is an accounting ratio calculated to assist in determining the financial

viability of a business. All licensees are required to meet a minimum liquidity ratio in
order to retain their licence. The minimum liquidity ratio for a licensee will be 0.8:1. A
more detailed description is contained in the Financial Requirements for Licensing. You
should obtain a copy of this document from the BSA Internet site at or from BSA and
discuss the particular information required with your accountant.

What is the formula for calculating the liquidity ratio?

Current Assets less Inventory / Current Liabilities less Financial Institution Facilities

Example:

Liquidity Ratio

= ($25,000 less $3,000) / ($30,000 less $10,000)

= $22,000 / $20,000

= 1.1 : 1

Originally, under the Financial Requirements for Licensing, Licensees were advised
that from 1 October 2000 the minimum liquidity ratio would be increased
from 0.8:1 to 1:1. Has this change occurred?

No. The BSA in conjunction with its stakeholders decided not to increase the minimum
level of liquidity ratio from 0.8:1 to 1:1 as it was felt this requirement would place a too
onerous financial obligation on Licensees. The minimum level of liquidity ratio remains
at 0.8:1.

The Queensland Building Services Board is currently considering whether to raise the
liquidity ratio to 1:1.

How will my liquidity ratio be expressed if I have no liabilities?

The liquidity ratio must still be provided even if there are no liabilities. It must be
expressed as a numerical ratio eg 1.1:1 on the Report prior to the certification by the
Accountant.

Please note BSA cannot accept Reports that do not have the liquidity ratio stated
correctly. The Report will be considered to be incomplete, and will require rectification
by the certifying accountant.
Do I include the amount of any Deeds in the liquidity ratio?

No. The amount being assured under a Deed of Covenant and Assurance is not included
in the liquidity ratio calculation.

What is included in the term “Current Financial Institution Facilities”?

The current balance of the bank overdraft facility together with the current balance of
other bank facilities such as credit cards and lease or hire purchase facilities. The term
also includes the amount of bank loans that would be repayable in the next 12 months.

What if a Licensee does not meet the liquidity ratio?

The Licensee is required at a minimum to meet a liquidity ratio of 0.8:1. If the Licensee
does not meet this minimum requirement the licensee’s licence will be suspended.

The Licensee owns a number of display/spec homes. Are they “inventory” and
therefore excluded from the liquidity ratio?

Yes. To the extent that the homes are current, rather than non-current assets, they would
be inventory and therefore excluded from the liquidity calculation.

The Licensee is a trustee of a trust. In calculating the liquidity ratio for the trust do
amounts owing by the trust to beneficiaries have to be included as current
liabilities?

The amounts owing by the trust to beneficiaries are certainly liabilities of the trust.
Whether those liabilities are current liabilities or non-current liabilities are for the
accountant to determine. In making this determination you must apply applicable
accounting principles, practices and policies. If the liabilities are properly classified as
current rather than non-current liabilities then those liabilities would be taken into
account in calculating the licensee’s liquidity.
 Current Ratio method - model for measuring liquidity

The Current Ratio (CUR) method is a model for measuring the liquidity of a company by calculating
the ratio between all current assets and all current liabilities. It is an indicator of a company's ability to pay
short-term obligations.

For the Current Ratio formula, see the picture on the left.

This ratio is also known as the working capital ratio and real ratio and is the standard measure of a
business' financial health. It will tell us whether a business is able to meet its current obligations by
measuring if it has enough assets to cover its liabilities.

For example, if a corporation has has M$50 in current assets to cover M$50 in current liabilities, this means
it has a 1:1 current ratio.

What is an acceptable current ratio?

This varies by industry. Generally speaking, the more liquid the current assets, the smaller the CUR can be
without cause for concern. For most industrial companies, 1.5 is an acceptable CUR. A standard CUR for a
healthy business is close to two, meaning it has twice as many assets as liabilities.

A thing to remember when using the CUR is that it ignores timing of both cash received and cash paid out.
Take the example of a company with no bills due today, but lots of bills that are due tomorrow. The
company also owns a lot of inventory (as part of its current assets). However the inventory will only be sold
in the longer term. This company may show a good current ratio, but can not be considered as having a
good liquidity.

Book: Steven M. Bragg - Business Ratios and Formulas : A Comprehensive Guide -

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Book: Ciaran Walsh - Key Management Ratios - Search at Amazon

Compare also: Quick Ratio | Cash Ratio | Z-Score | Discounted Cash Flow | Free Cash Flow |
Economic Value Added | Economic Margin | CFROI | Return on Invested Capital

Cash Ratio model - method for measuring liquidity

The Cash Ratio (CAR) method is a formula for measuring the liquidity of a company by calculating
the ratio between all cash and cash equivalent assets and all current liabilities.

It excludes both inventory and accounts receivable in comparison to the Current Ratio.
The CAR model measures only the most liquid of all assets against current liabilities, and is therefore seen as
the most conservative of the three liquidity ratios.

For the Cash Ratio formula, see formula above

This CAR ratio is also known as the Liquidity Ratio and Cash Asset Ratio.

The formula is an indicator of the extent to which a company can pay current liabilities without relying on
the sale of inventory and without relying on the receipt of accounts receivables.

A thing to remember when using the Cash Ratio formula is that it ignores timing of both cash received and
cash paid out.