Financial liquidity in the company – financial liquidity ratios
In the previous post titled “Financial liquidity in a company – how to determine it?” we emphasized why financial liquidity in an enterprise is important and how it can be assessed. In this article, we will introduce individual financial indicators that not only allow you to assess financial liquidity, but also the overall performance of an enterprise.
Current financial liquidity ratio
Thanks to the current financial liquidity ratio, we can determine the company’s ability to cover current liabilities by checking the frequency of covering them by current assets. To maintain financial balance, this ratio should not exceed 1.2-2.0 range. This means that the total assets should be around twice the value of financial liabilities. Interestingly, neither well below 1.2 nor well above 2.0 is good. In the first case, it means that the company is unable to cover its liabilities, and in the second case that it is not investing, has excessive stocks or difficult to collect debts, which may negatively affect its development and in the future, also financial liquidity.
The formula for calculating the current financial liquidity ratio is: dividing current assets by current liabilities.
Accelerated liquidity ratio
Thanks to the accelerated liquidity ratio, we find out how many times we “use” our highly liquid assets to cover current liabilities. We do not include financial inventory in calculating these values. The level allowing to state that the company copes with covering current liabilities should be 1.0.
When we compare the ratio of current financial liquidity and accelerated financial liquidity, we will be able to assess the level of inventories held by the company. If the current liquidity ratio is high and the accelerated liquidity ratio is low, this may mean a high level of inventory, which indicates that part of the capital has been frozen. The reverse result of the indicators, in turn, proves that the company manages its cash in a less productive way.
The formula for calculating the accelerated financial liquidity ratio is: (current assets minus inventories) by current liabilities.
Thanks to the cash ratio, it is possible to indicate the part of liabilities that we can cover through the use of cash assets or short-term investments. Assets that can cover liabilities in the shortest time are included. Lack of cash may lead to losses resulting, among others due to the inability to conclude new transactions.
The formula for calculating the cash ratio is: dividing short-term investments by current liabilities.
Immediate liquidity ratio
The immediate financial liquidity ratio is the ratio of cash making it possible to recover cash within 3 months to liabilities which repayment falls within the next 3 months. There is no indicator determining the level of the immediate financial liquidity ratio. The assessment is made on the basis of a comparison of values over time.
The formula for calculating the immediate liquidity ratio is: dividing cash and other financial assets by current liabilities for up to 3 months.
Remember that the correct combination of all financial liquidity ratios is not an easy task. It requires knowledge and experience, and for a proper bill it is necessary to conduct a thorough audit of the company. Therefore, it is worth entrusting such a task to a specialist who objectively looks at the condition of your company or supplier and recommends solutions that will restore financial liquidity in it.