Current Ratio and Liquidity Ratio
As we’ve discussed before calculating your quick ratio is an easy formula to understand how efficiently your company can grow. The higher the quick ratio the more efficient a company can grow. An example quick ratio formula can be found below:
Quick Ratio Formula = (New MRR + Expansion MRR) / (Contraction MRR + Churned MRR)
In addition to the quick formula, we see many startups track two other financial ratios: current ratio and liquidity ratio. Tracking different financial ratios can be an integral part of a companies’ success as they offer a quick and easily digestible way to understand where your company stands. Where a quick ratio observes your short term financials, the current ratio and liquidity ratio observe all of your assets and long term obligations.
Liquidity ratio or liquidity ratios are often seen in a similar sense as a quick ratio and can be used as an umbrella term. Both quick ratios and current ratios are a different form of liquidity ratios. According to Investopedia, “Liquidity ratios are an important class of financial metrics used to determine a debtor’s ability to pay off current debt obligations without raising external capital. Liquidity ratios measure a company’s ability to pay debt obligations and its margin of safety through the calculation of metrics including the current ratio, quick ratio, and operating cash flow ratio.”
Liquidity ratios are important to startups and their investors because it helps determine if a startup can meet their current debt obligations.
As mentioned above, a current ratio is a form of a liquidity ratio. A current ratio is a longer term look at a companies’ debts and assets. The current ratio formula is very simple and can be found below:
Current Ratio Formula = Current Assets / Current Liabilities
While different companies may interpret what counts as an asset differently, a current ratio of 1 is generally accepted as a good current ratio value. Whereas a quick ratio often observes just your recent revenue, a current ratio takes a holistic view at all of your assets and liabilities which causes a bit more variance from company to company.
All in all, tracking your liquidity ratios (current ratio and quick ratio) can offer both startup leaders and investors a high level view of the companies ability to grow and cover their debt obligations.