In our previous post entitled. „Financial liquidity in a company - how to determine it?” we pointed out why financial liquidity in a company is important and how it can be assessed. In this article, we will take a closer look at the various financial ratios that not only allow us to assess liquidity, but also the overall functioning of the company.
Current ratio
With the current ratio, we can determine a company's ability to cover its current liabilities by checking how often they are covered by current assets. For financial equilibrium, this ratio should not exceed 1.2-2.0. That is, the total assets should be approximately twice the value of the financial liabilities. Interestingly, neither a result significantly below 1.2 nor significantly above 2.0 is good. In the first case, it means that the company is not able to cover its liabilities, and in the second case, it means that it is not investing, has excessive inventories or difficult to collect receivables, which can negatively affect its growth and, in perspective, also its liquidity.
The formula for calculating the current ratio is: dividing current assets by current liabilities.
Accelerated liquidity ratio
With the accelerated liquidity ratio, we find out how many times we „use up” our highly liquid assets to cover current liabilities. When calculating these values, we do not include financial stocks. The level to conclude that a company is managing to cover its current liabilities should be 1.0.
When we put together current ratio i accelerated liquidity ratio, If the current ratio is high and the accelerated ratio is low, this indicates a high level of inventory, indicating that some capital has been frozen. If the current ratio is at a high level and the quick ratio is low, this indicates a high level of inventories, indicating that part of the capital has been frozen. The opposite result of the ratios, on the other hand, indicates that the company manages cash in an unproductive way.
The formula for calculating the accelerated liquidity ratio is: (dividing current assets minus inventories) by current liabilities.
Cash ratio
With the cash ratio, it is possible to indicate the proportion 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 taken into account. A lack of cash on hand can lead to losses due to, among other things, an 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 liquidity ratio is the ratio of cash recoverable within three months to liabilities due within the next three months. There is no determinant for the level of the immediate liquidity ratio. The assessment is made by comparing values over time.
The formula for calculating the immediate liquidity ratio is: dividing cash and other financial assets by current liabilities up to 3 months.
Remember that correctly putting all liquidity ratios together is not an easy task. It requires knowledge and experience, and for a correct account it is essential to carry out a thorough company audits. It is therefore worth commissioning such a task to a specialist who will take an objective look at the condition of your company or supplier and recommend solutions to restore liquidity in it.
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