General liquidity ratio - the ease of selling or converting certain tangible or any other values into real money in order to cover current financial liabilities. Thus, the analysis of this ratio provides a forecast of whether the company can fully cover all the financial obligations that it currently has.
What is determined by liquidity?
All assets held by a particular company are fully displayed in its balance sheet, and each of these factors has its own liquidity:
- funds currently present at the box office or on the company's accounts;
- securities or bank bills;
- receivables present, as well as corporate securities and loans issued;
- stocks of raw materials and goods present in warehouses;
- buildings and constructions;
- equipment and machinery;
- unfinished construction.
What it is?
The total liquidity ratio is a financial indicator, for the calculation of which the enterprise reporting is used. This tool allows you to determine whether a company can pay off current debt using its current assets. The main point of such indicators is to compare the amount of debts of the company with its working capital necessary to ensure repayment of such debts.
Thus, we consider several liquidity ratios, as well as formulas for their calculation:
- total liquidity ratio;
- quick ratio;
- absolute liquidity ratio;
- net working capital.
Current liquidity
The current liquidity ratio (coverage ratio or total liquidity ratio) is the ratio of the company's current assets to various short-term liabilities present. The source of this data is the balance sheet. At the same time, there is nothing difficult in calculating the total liquidity ratio if all the necessary information is available. The formula is as follows:
- current assets (not including long-term receivables) / all present Short-term liabilities.
What is he showing?
This ratio shows whether the company can repay any current liabilities using only its current assets. The higher this indicator, the stronger the solvency of a particular organization will increase. The general liquidity ratio, the calculation formula of which was shown above, determines not only how solvent the company is at the moment, but also allows you to determine the financial condition of the company in the event of any emergency.
The normal indicator of this coefficient is from 1.5 to 2.5. In this case, the figure will depend on the area in which the company in question operates. It should be noted that any deviations are both unfavorable both below and above the established norm. If the current (total) liquidity ratio is less than 1, then this indicates a serious financial risk, because the company does not have the ability to consistently pay its short-term obligations. In the event that this coefficient has a value of more than 3, then the capital structure used by the enterprise may be recognized as irrational.
Depending on the field in which the company operates, as well as on the basis of the quality and structure of the assets available to it, this value can vary significantly.
Features
It is worth noting that the coverage ratio (total liquidity) alone does not provide a complete picture of the work of an organization. In the overwhelming majority of cases, those companies that have insignificant production and material inventories, but at the same time have access to money on promissory notes for payment, can safely work with lower rates of this ratio. What can not be said about enterprises that have large stocks of material assets and sell their goods on credit.
Another option for verifying the adequacy of the assets present is to determine the urgent liquidity. It is worth noting that often all kinds of suppliers, banks and shareholders are interested in this particular indicator, rather than trying to find out the overall liquidity ratio of the balance sheet, since the company in the course of its work may encounter various circumstances in which it will need to instantly pay off certain unforeseen expenses . Thus, she will need to use all the securities, cash accounts receivable, as well as any other means, that is, all assets that can eventually be converted into cash.
What does this ratio show?
Quick ratio It also allows you to determine whether a company can pay off all current liabilities present using current assets. In this, he is similar to what constitutes the value of the general liquidity ratio. But in this case, the difference is that the calculation uses exclusively medium-liquid, as well as highly liquid current assets, which include money in operational accounts, all kinds of raw materials, goods, and also receivables with a short maturity.
What is its difference from the general?
In principle, the general liquidity ratio characterizes the same thing, but in this case, the calculation process uses completely different indicators, that is, incomplete production is not taken into account, as well as the company's stocks of specialized materials, semi-finished products and all kinds of components. A balance sheet is also used as a source of all the necessary information, but at the same time, the stocks present at the company are not taken as part of the assets, because if their forced sale is necessary, losses will be as possible.
How important is it?
In fact, many do not understand that this financial ratio is one of the most important and demonstrates how many short-term liabilities can be immediately repaid using various funds on the accounts, as well as short-term securities or receipts from accounts receivable debt. The higher this indicator, the higher will be the solvency of the company. A normal indicator is a value of more than 0.8, which shows that upcoming receipts and cash already in the company can fully cover the current debts of the company.
How to increase it?
In order to increase the value of this indicator, it is necessary to take measures aimed at increasing the working capital present, as well as attract all kinds of long-term loans and credits. However, if the value of this coefficient is more than three, this may indicate that the capital structure is irrational. There are many reasons why such liquidity can be formed. Examples: slow turnover of finances invested in various stocks, as well as an increase in receivables.
For this reason, it is important to consider also absolute liquidity ratio, whose value should be higher than 0.2.
What does the absolute liquidity ratio show?
This ratio demonstrates how much short-term debt an organization can repay using only the most liquid assets, that is, short-term securities, as well as the cash it has.
Absolute liquidity ratio is the ratio of cash, as well as short-term financial investments present to all short-term liabilities, i.e. current liabilities company. The source of the required information is the balance sheet in the same way as in determining current liquidity, but in this case only cash and equivalent funds are taken into account.
What should it be like?
As mentioned above, maintaining the value of this indicator more than 0.2 is considered the norm. The higher this figure, the better the solvency of the company. Again, an overestimated indicator indicates that the company uses an irrational capital structure, and there is too much unused assets.
Thus, if the cash balance is maintained at the reporting date level, then all short-term debt present at the company at this date can be fully repaid within five days. This regulatory restriction is used in the process of financial analysis by foreign experts. However, there is no exact justification for what reason, in order to maintain a normal level of liquidity, the amount of cash present should cover at least 20% of all current liabilities.
However, in any case, it is best to try to ensure that this indicator corresponds to a certain value and your company has sufficient absolute liquidity in the current market, as this will contribute to the competitiveness of the enterprise and the attraction of additional investments.
