How to know the liquidity of your company?
Knowing the liquidity of your business It is a fundamental issue, representing a key factor for SMEs and the self-employed.
In this sense, economic ratios are valuable indicators to know how your company is doing.
In addition, they help you manage it according to its situation and results.
Therefore, calculating these ratios and implementing them as benchmarks allow strategic management decisions to be made.
Although uncertainty is inherent to your business, this data allows you to better understand your situation and anticipate possible adversities.
What are the most useful economic ratios for companies?
In the business field, it is not enough just to want to take advantage of these ratios to improve the direction of the organization.
Also, you need choose correctly which ones you calculate and how you interpret them.
To do this, we present a selection of the most revealing and useful in the analysis of the economic and financial situation of a company.
Financial autonomy ratio
Relate the debts that your business has, both short and long term, with the available own resources.
Its calculation is obtained by dividing own resources by third-party resources.
The result shows the financial autonomy and gives an idea about the structure of the Sources of funding.
It depends on both the sector of activity and the age of the company:
Own Funds / (Non-Current Liabilities + Current Liabilities)
liquidity ratio
Thanks to him, you will know if your company is going to be able to face its economic commitments in the short term.
To find it, you must divide the current assets by the current liabilities.
If the result is greater than one, you can rest easy, although it should be related to other ratios.
Its value will depend on the sector of activity, since some companies with a liquidity ratio of less than one are also solvent.
Current Assets / Current Liabilities
Treasury ratio
Also known as immediate liquidity ratio, define if your company is capable of meeting its payment obligations in the short term.
The applicable formula is the sum of available assets (temporary financial investments and cash) and realizable assets, divided by current liabilities.
Ideally, it should tend to zero (between 0,1 and 0,3), since the return on cash is very low or non-existent.
Cash and other cash equivalents / Current Liabilities
Economic profitability
You want to know What capacity do your assets have to generate profits??
Or what is the same, how much profit do you get for every euro you invest in the company.
To do this, you just have to divide the result before the discount for amortization, depreciation, interest and taxes between the total assets.
It is relevant that its value is above the cost of financing.
EBITDA / Total Assets
Financial profit
This ratio, also known by the acronym ROE due to its nomenclature in English (Return on Equity), establishes what ability the organization has to reward its shareholders.
It relates the economic benefit with the resources necessary to achieve them.
Do you want to find it?
Make this division: net profit between own funds.
Its value must be sufficient to satisfy the shareholder, being of a subjective nature as it depends on the investor's profile.
Result for the year / Equity
average payment period
¿How long does it take to pay your suppliers??
In other words, what relationship exists between the average balance of accounts payable and your daily purchases.
The greater the result obtained, the more you are financing yourself through them.
The calculation is the quotient between the average balance of suppliers and purchases, multiplied by 365 days.
It is interesting that its value is in line with the average collection period or if it is possible that it is higher.
365 * (Suppliers + Various Creditors) / Supplies
Average collection period
It reflects how long it takes, on average, to collect from your customers.
That is to say, how many days pass from when you sell a product until you collect it.
The formula is similar to the previous one, it is the quotient between the average customer balance and sales, multiplied by 365 days.
The lower its value, the lower the investment that must be made to finance customers, although it must always be in tune with the company's commercial policy.
365 * (Trade debtors and other accounts receivable – Customer advances) / Net turnover
Liquidity ratios: interpretation and characteristics
Although the liquidity ratio is one of the most revealing, there are multiple adaptations that can help us understand what the real situation of corporate liquidity is.
Therefore, we are going to list some of the most effective ones to carry out this economic x-ray:
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solvency ratio
It reflects to what extent the company can pay its current liabilities (those that are paid in one year) with its current assets. Its calculation is obtained through the quotient between current assets (formed by cash, accounts receivable and inventories) and current liabilities.
Realizable assets / Current liabilities
- Acid test
It measures short-term liquidity, ignoring inventories, with respect to short-term liabilities. This modality of the liquidity ratio penalizes inventories in current assets since, as a general rule, they are not very liquid. However, for a correct interpretation, the company's sector of activity must be taken into account, since there are sectors in which a minimum stock is inherent.
(Current assets – Inventories) / Current liabilities
- Working capital
It is easily calculated, since it is enough to subtract current liabilities from current assets. Establishes the ability to face short-term debts. It is useful to know if the assets that are going to remain in the company for a maximum period of one financial year are sufficient to meet all payment obligations.
Current assets – Current liabilities
Analysis reference liquidity
After listing all the reasons why liquidity must be a constant reference in your analysis, we hope that now you have a clearer understanding of how to do it and what indicators to use.
In this way, you will be able to anticipate and adopt the appropriate economic or financial measures.
From Workcapital we provide the necessary liquidity for SMEs and the self-employed.
Know all the advantages you can get with the financing of companies from Workcapital
