Liquidity ratio mostly refers to the current ratio, a main financial metric for measuring a company's ability to pay off its short-term liability obligations. The current ratio is calculated as current assets divided by current liabilities. The higher the ratio is, the more likely a company has enough cash-convertible, short-term assets to cover current liabilities. Different industries try to maintain different levels of liquidity ratios based on the cash convertibility of their particular types of current assets and the amount of current liabilities their companies usually carry.
Current assets held by grocery stores can be more easily convertible to cash than those in some other industries, such as manufacturing or even wholesalers carrying the same merchandises as grocery stores. Grocery stores have a relatively high inventory turnover from daily retail sales, generating cash inflows on a continuing basis. As a result, grocery stores tend to keep relatively low levels of current assets and don't set aside a lot of cash. Any liabilities coming due can be met with ongoing sales. Thus, liquidity ratio for a grocery store is relatively low.
Trade payables, or accounts payables, are short-term trade credit extended by a seller to a buyer, allowing the buyer to purchase on accounts without paying cash until later. In the grocery store industry, many food manufacturers and other household goods producers are willing to place their products on store shelves without asking for immediate payments. Therefore, grocery stores usually carry relatively large amounts of trade payables, directly increasing the total amount of current liabilities, which is another reason why liquidity ratio for a grocery store can be low.
Liquidity ratio is one of the major financial metrics that banks and other creditors use to determine whether a company can turn current assets into cash to cover debts when they are seeking payments. Creditors often favour retail businesses, including grocery stores, when providing credit, especially short-term financing, because they can easily seize retail revenues as collateral. Less concerned about the level of their liquidity ratios due to the easy credit access, grocery stores normally don't have the incentive to try to maintain a perfect liquidity ratio.
The industry average liquidity ratio for grocery stores is lower than that for many other industries. Liquidity ratios for grocery stores usually stand at between 1 to 2. A liquidity ratio of 1 indicates that a company has an equal amount of current assets and current liabilities. Given that not all current assets are readily convertible to cash, creditors and companies alike normally don't consider a liquidity ratio of 1 as a safe cushion. The rule is that liquidity ratio should be close to 2 to provide enough liquidity protection. Because of grocery stores' quick cash convertibility and easy credit access, their average liquidity ratio is below the conventional optimal level.