Using Liquidity Ratios and Cash Flow Management With Xero

Future Accounting
Oct 21
4 min read

Updated: Oct 23

Strengthen your business finances through cash flow management with Xero

When it comes to running a successful business, cash is king. But how do you really know if your business has enough cash or easily accessible assets to cover its short-term obligations? That’s where liquidity ratios come in.

Whether you’re a current client or just starting to explore working with us, understanding liquidity ratios and cash flow management with Xero will empower you to make more informed decisions, avoid cash crunches, and plan for sustainable growth.

What are liquidity ratios?

Liquidity ratios measure your business’s ability to pay off short-term debts using short-term assets. These ratios are critical indicators of financial health and are often closely reviewed by lenders, investors, and even suppliers.

Three key liquidity ratios every business owner should know

1. Current ratio

Formula: Current assets ÷ Current liabilities

This ratio tells you whether your business has enough short-term assets (like cash, receivables, and inventory) to cover your short-term liabilities (such as payables, wages, and taxes due within a year).

Ideal benchmark: 1.5 to 2

Example: Current assets of $120,000 ÷ current liabilities of $80,000 = 1.5

This means you have $1.50 in current assets for every $1 in liabilities, which puts you in a comfortable position to meet your short-term obligations.

2. Quick ratio (acid-test ratio)

Formula: (Current assets – Inventory) ÷ Current liabilities

This stricter ratio excludes inventory because it isn’t always easy to convert into cash. It reflects your ability to pay short-term obligations using your most liquid assets.

Ideal benchmark: 1 or higher

Example: ($120,000 – $40,000 inventory) ÷ $80,000 = 1.0

You have exactly enough quick assets to cover your liabilities, which is reasonable but could be improved.

3. Cash ratio

Formula: Cash + cash equivalents ÷ Current liabilities

This is the most conservative measure of liquidity, only considering cash and near-cash items.

Ideal benchmark: 0.5 to 1

Example: $30,000 ÷ $80,000 = 0.375

This shows you only have 37.5 cents in cash for every $1 of liability. While not uncommon, it highlights a potential cash flow risk.

Why liquidity ratios matter for your business

By tracking liquidity ratios, you can:

Spot short-term financial risks before they become problems
Build confidence with lenders and investors
Negotiate better terms with suppliers
Prepare for growth with a stronger financial foundation

However, these ratios are only as reliable as the data you’re working with and the cash flow strategies you implement.

Practical strategies to improve liquidity

Improving liquidity often comes down to smart management and proactive planning. Some strategies include:

Tighten credit terms: Shorten payment periods and follow up promptly on overdue invoices.
Delay non-essential spending: Avoid large outflows and renegotiate payment terms with suppliers.
Build a cash reserve: Keep a buffer for unexpected costs and automate savings for tax or payroll.
Improve inventory management: Avoid overstocking and free up cash tied in unsold goods.

How Xero invoicing helps you manage cash flow

One of the most effective ways to boost liquidity is by getting paid faster, and that’s where Xero comes in. With Xero’s invoicing tools, you can:

Send invoices instantly: Create and send professional invoices from your desktop or mobile.
Automate reminders: Set up automatic payment reminders to encourage timely payments.
Accept online payments: Enable instant payments via Stripe, GoCardless, or credit card.
Track in real time: See when an invoice is opened and when payment is received.

Example: If you typically send 10 invoices a month averaging $5,000 each, you may be waiting on $50,000 for up to 30 days. By enabling Xero’s online payments and reminders, you could reduce the average payment time to 10 days - improving your liquidity by receiving $33,000 earlier.

Take control of your financial health today

Liquidity issues don’t happen overnight, but the signs are there if you know where to look. By regularly monitoring your liquidity ratios and taking advantage of tools like Xero, you can strengthen your cash flow and grow your business with confidence.

Ready to improve your cash flow and gain a clearer picture of your financial health? Book an appointment with Future Accounting today and let’s put Xero to work for your business.

Disclaimer  

This article does not constitute financial advice and is for general information only. It does not take into account any individual’s personal objectives, situation or needs, and is not intended as professional advice. Any similarity to an individual’s personal circumstances and the examples provided in this article is purely coincidental. Any person acting upon such information without receiving specific advice, does so entirely at their own risk.  

Authorisation under an Australian Financial Services Licence (AFSL) is not required in the provision of this article and the author plus Future Accounting Group Pty Ltd is not acting in its capacity as an Australian Financial Services Licence holder 

Liability limited by a scheme approved under professional standards legislation.