When a bank or any other financial institution considers the approval of funds to its client, an essential part of that process is the analysis of the company's operations by departments specialized in financial analysis and credit risk analysis.

Depending on the complexity of the financing application, the financial analysis can be more extensive and comprehensive or simpler. In any case, there are certain financial indicators that are always observed. An indispensable part of any analysis are liquidity indicators, the most famous of which are the current ratio and the quick ratio.

The current ratio simply divides short-term, current assets by current liabilities. This ratio shows whether the company has enough liquid assets that can be quickly converted into cash and pay off short-term liabilities.

The generally accepted standard is that this ratio should be at least 1.2, with the fact that depending on the industry, the limit can be moved slightly downwards or upwards (e.g. due to their business nature, a construction company and a wholesaler cannot be expected to meet the same indicators). A value of 1.2 or above indicates that the company has enough short-term assets that can be converted into cash to meet its short-term obligations, and that it still has an additional amount of funds it can invest in operations.

The current ratio is particularly significant when deciding on lending with short maturities, up to one year, intended for the acquisition of working capital.

The quick ratio is similar to the current ratio except that this ratio does not take into account the company's inventory.

Quick ratio for the balance sheet illustration shown above:

Although it is part of current assets, inventory is considered a less liquid form of assets, and the quick liquidity ratio aims to show the proportion of the most liquid forms of assets to liabilities. The generally accepted preferred value for this ratio is 1.00.

If there is a large difference between current ratio and quick ratio in a longer period, this may also indicate problems with inventory, inventory accumulation, poor management, etc.

Of course, we are all aware that although everything sounds good in theory, real life often deviates from theory. Thus, companies that have high values of current ratio or quick ratio can find themselves in a situation where they lack cash in the short term. This is most often a consequence of the fact that the inflows from the collection of receivables do not follow the maturities in which the obligations must be paid.

If your company finds itself in this situation, FS can help you to turn your overdue, unpaid invoices into cash within 24 hours and thereby improve the liquidity ratio and readily meet all your obligations.