A company rarely goes bankrupt because it makes a loss. It goes bankrupt because at some point it can no longer pay its invoices. Calculating liquidity is therefore the quickest check you can run on a customer, a supplier or your own business. In this article you learn to calculate the current ratio, the quick ratio and net working capital with the balance sheet codes from Belgian annual accounts, and what a good value is.
What is liquidity?
Liquidity is the ability of a company to pay its short-term debts: suppliers, the NSSO (social security office), VAT, the bank that wants part of the loan back this year. The question is simple: against everything that has to be paid within the year, is there enough that can be turned into cash within the year?
The working capital at the centre of this article is also the first ratio of the Altman Z-score, which brings liquidity, solvency and return together in one predictor.
Those "things that can be turned into cash quickly" are called current assets on the balance sheet: stock, customer receivables, cash investments and cash itself. The debts falling due within the year are called amounts payable within one year. All liquidity ratios set those two against each other.
Current ratio, quick ratio and net working capital
There are three measures that each use the same starting point but get stricter:
Quick ratio (liquidity in the narrow sense) = (current assets minus stock) / amounts payable within one year
Net working capital = current assets minus amounts payable within one year
The current ratio counts everything that is current. The quick ratio leaves out stock, because stock cannot always be sold quickly and at full value: think of a clothing shop with the winter collection in March, or a builders' merchant with specific parts. Net working capital (also called working capital) is not a ratio but an amount in euros: how much is left if you paid all short-term debts with your current assets.
Which balance sheet codes do you need?
- Current assets: code 29/58. Receivables due after more than one year (29), stock and contracts in progress (3), receivables due within one year (40/41), cash investments (50/53), cash at bank and in hand (54/58) and accruals (490/1).
- Stock: code 3. You deduct this for the quick ratio.
- Amounts payable within one year: code 42/48. The part of long-term loans falling due this year (42), suppliers (44), taxes, remuneration and social security (45) and other debts.
Strictly speaking, receivables due after more than one year (code 29) do not belong in a liquidity calculation. At most SMEs that item is zero or negligible, so in practice almost everyone works with 29/58.
Worked example from annual accounts
Take a wholesaler of building materials with the following figures at 31 December:
| Balance sheet item | Code | Amount |
|---|---|---|
| Stock | 3 | €150,000 |
| Trade receivables | 40 | €250,000 |
| Cash at bank and in hand | 54/58 | €100,000 |
| Current assets | 29/58 | €500,000 |
| Amounts payable within one year | 42/48 | €350,000 |
- Current ratio = 500,000 / 350,000 = 1.43. For every euro that has to be paid within the year, there is €1.43 in current assets.
- Quick ratio = (500,000 - 150,000) / 350,000 = 1.00. Without selling the stock, the company can just pay all its short-term debts.
- Net working capital = 500,000 - 350,000 = €150,000. That buffer is financed with equity or long-term loans.
The gap between 1.43 and 1.00 tells a story in itself: almost a third of the current assets is tied up in stock. If that stock moves slowly, real liquidity is closer to 1 than to 1.43.
What is good liquidity?
For the current ratio these benchmarks are used in practice. They apply to an average SME and not as an absolute law:
| Current ratio | Assessment | What it means |
|---|---|---|
| < 1 | Risk | More falls due within the year than there are current assets to match. The company lives on new turnover, deferrals from suppliers or an overdraft. |
| 1 to 1.2 | Tight | It works, but one big non-payer or a slow month can upset the balance. |
| 1.2 to 2 | Healthy | Enough buffer to absorb setbacks without leaving excessive money idle. |
| > 2 | Possibly too generous | Safe, but perhaps too many idle funds: cash that earns nothing, customers paying too late or too much stock. |
For the quick ratio the bar is lower: around 1 is comfortable, below 0.5 the company becomes very dependent on its stock rotation.
Liquidity versus solvency and cash flow
Three concepts that often get mixed up, but each answers a different question:
- Liquidity: can the company pay the invoices of the next twelve months? A snapshot at the balance sheet date.
- Solvency: can the company carry its total debt burden in the long term? Calculated as equity divided by total assets. More on that in solvency ratio of a Belgian company, or calculate both ratios together with the health score tool.
- Cash flow: how much money does the company generate from its operations over a whole year? A flow instead of a position.
A company can be very solvent and still have a current ratio of 0.7 because all its capital is tied up in bricks. And a company with a fine current ratio can have negative cash flow because it reinvests its profit in stock and customer credit. Why profit and money in the bank are not the same is explained in profit versus cash flow.
The balance sheet date can distort
Liquidity is a photo of one day, usually 31 December. A company that collects from a big customer or clears its overdraft just before year-end looks better than it is on average. So also look at customer credit in days (DSO): that shows how the money really moves throughout the year. How to calculate it is explained in the DSO check.
What should a supplier conclude from this?
Anyone who supplies on credit gives credit. In a bankruptcy suppliers are only paid after the preferred creditors (NSSO, tax authorities, bank), so your customer's current ratio is your first measure of risk. Practical rules of thumb:
- Current ratio below 1: ask for a deposit or payment on delivery, certainly for a first order or a large amount. Limit your outstanding balance to what you can afford to lose.
- Current ratio between 1 and 1.2: supply on credit, but apply a short payment term (30 days, the legal default when nothing has been agreed) and follow up due dates strictly.
- Current ratio above 1.2: normal conditions. Do look at the trend: a ratio dropping from 1.8 to 1.2 in two years matters more than the figure itself.
- Quick ratio far below the current ratio: the customer is sitting on a lot of stock. In a sector with fast-ageing stock (fashion, electronics) that is an extra risk.
Declining liquidity rarely comes alone. Combine it with the other warning signs from 5 signs pointing to an approaching bankruptcy: rising debts to the NSSO and the tax authorities, late filing and negative equity.
Looking up liquidity on Jaarrekening.be
You do not have to pull the codes out of the National Bank annual accounts yourself. Look up a company via the company search and open the Key financials tab. Under Liquidity you find the current ratio and quick ratio for every filed financial year, with a chart of the evolution over several years. Below that you find the underlying balance sheet items (cash, trade receivables, stock, short-term debt), working capital and customer and supplier credit in days, so you immediately see where a change comes from. Comparing sector peers is possible through advanced search.
In summary
Calculating liquidity is a division of two balance sheet items: current assets (29/58) by amounts payable within one year (42/48). Deduct stock (3) for the stricter quick ratio. A current ratio between 1.2 and 2 is healthy for most SMEs, below 1 is a risk that you as a supplier had better cover with a deposit. Always read the figure within its sector, over time and together with solvency and cash flow.