Liquidity indicators: what are they and why should they be monitored?

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Liquidity indicators: what are they and why should they be monitored?

Table of Contents

Liquidity indicators are data with which managers have a clearer perspective on financial health of your business, as well as more precision for decision making.

Whether to reduce expenses, improve financial management or even to constantly evaluate and improve the capacity of your company's finances, liquidity indicators can make all the difference.

In order for you to understand in advance what we are going to deal with in this article, take a look below at what will be covered in the next topics:

    • What is the importance of knowing the liquidity indicators?
    • What are the existing indicators?
    • Current liquidity indicator
    • Dry liquidity indicator
    • Indicators of immediate liquidity
    • General liquidity indicators
    • How to make an analysis of liquidity indicators?
    • What is the influence of liquidity indicators on decision making?

Good reading!

What is liquidity?

Before we talk about liquidity indicators and the interpretation of each one, let's understand the essence of its concept: liquidity.

In general, we are talking about the ability of an asset to be transformed into cash without, therefore, losing its value.

No wonder, if we say that an asset has high liquidity, it is understood that it will be easy to sell it and, thus, turn it into cash.

At the financial market, the assets can be the shares or even your popular passbook savings. Each type of investment has a type of liquidity, and it is important to know how the liquidity indicators generate profitability and indebtedness because of this.

In the business world, we are talking directly about the relationship of the company and its production with its financial capacity and, also, about its patrimonial protection.

What is the importance of knowing the liquidity indicators?

In a nutshell, we can embark on the subject of liquidity indicators and the interpretation of these metrics, exploring, precisely, the value of each one of them for the financial maintenance of a company.

That, in itself, would justify its monitoring, right?

But you can go much further in that answer. No wonder, there are four types of these indexes:

  • current liquidity indicators;
  • dry liquidity indicators;
  • indicators of immediate liquidity;
  • general liquidity indicators.

Each time you calculate the indicator according to your needs and interests, the result points the direction to be followed to make sure that a certain issue has good (or not) financial capacity and / or resilience.

To make it easier, we will show below what are the liquidity indicators and how each of them relates to your goals and the characteristics of your company.

What are the existing indicators?

As we highlighted in the previous topic, these four indicators can be monitored. See, in detail, how they relate to your company's financial sector!

Current liquidity indicator

If the name doesn't sound familiar, you may have heard of the term “common liquidity”, which is basically a synonym for current liquidity indicators.

Through it, it is possible to measure the capacity of your business to honor short-term financial commitments. In this way, the finance sector has no surprises and understands what are the expenses / accounts whose attention should be immediate – and also how much this will impact on the company's economies later.

To calculate your current liquidity indicator, it is necessary to know what are your current assets (goods that, in the short term, can be converted into cash), which can be accounts receivable, for example, your goods or even cash in hand, at the moment.

Then, identify the current liabilities, which are the financial obligations. They can be accounts payable, taxes due or even a debt with one of your suppliers, among others.

See below the formula for calculating your current liquidity indicators:

current liquidity = current assets / current liabilities

Dry liquidity indicator

Although it is very similar to the current liquidity indicators, the dry liquidity indicator always has a value less than or equal to the metric we saw earlier.

The reason for this is easily explained: here, we do not include stock data in the calculation. In general, because these assets are not tied to the company's equity.

So, the formula for reaching dry liquidity indicators is as follows:

dry liquidity = (current assets – inventory) / current liabilities

It is worth noting, however, that this is not a worthy indicator to monitor for companies that do not deal with inventories whose data are measurable.

This is the case, for example, of SaaS companies Software as a Service – those that negotiate digital products, therefore, that are not stacked in physical stock, properly said).

Indicators of immediate liquidity

Quite associated with cash, bank balances and financial investments, the immediate liquidity indicator nor does it need to take inventory, accounts receivable, or other incoming amounts into account.

In this way, its management is able to accurately assess all types of very short-term situations.

Here, the idea is to consider only your financial capacity within the cash available at the moment, and within a period of up to 90 days.

The formula for knowing this type of index is as follows:

immediate liquidity indicator = cash and cash equivalents / current liabilities

General liquidity indicators

The last of liquidity indicators is the only one among them that focuses on a medium and long term. In the period analyzed, therefore, we are talking about financial obligations and pending issues up to 12 months.

This includes, in general, other data under the spotlight, such as:

  • loans;
  • long-term applications;
  • installment sales.

The indicator can be used for several purposes. But, in general, it is used to ascertain the financial capacity to make extensive commitments, such as an investment.

Its formula can be checked below:

General liquidity = (current assets + long-term assets) / (current liabilities + medium / long-term obligations)

How to make an analysis of liquidity indicators?

As we highlighted, we will talk about the liquidity indicators and the interpretation of the results. It is useless to know the formula of each one if we do not understand its practical application, right?

It is worth noting, before proceeding, that this is not supernatural. In fact, liquidity indicators can be interpreted through the aid of a table that is considered a parameter rule for everyone. Here's just how it works:

  • results greater than 1 mean that your company has a good degree of liquidity;
  • results below 1 mean that there is no means to settle, at least for the moment, your pending issues;
  • results equal to 1 show that the available resources will serve to honor your payments.

See how there are not many secrets on the subject? If the result is less than or equal to 1, it is important to analyze the financial health of the company.

This does not mean, however, that your business is on the verge of bankruptcy, but it is a sensitive issue in the short term – or even that there is capital, yes, but only for long-term situations.

It is worthwhile, however, to rely on other data regarding good decision making with regard to your company's finances.

To learn more about this, also read the article >>> Analysis of financial indicators: how to do and which to measure?

What is the influence of liquidity indicators on decision making?

We have seen, throughout the article, that liquidity indicators allow us to assess whether the moment allows decision making focused on investments in the short, medium and long term.

In other words, each of your choices can be guided by the results of this monitoring. Thus, the financial sector knows if it can honor the commitments of the month, for example, and you have a comparative parameter to position yourself regarding your balance sheet, among other possibilities.

These are data, therefore, that favor an accurate and factual observation of the moment that your company lives, financially. Not to mention that you can perform other tasks, such as:

It also means that it is a constant job. The liquidity indicators will change as payments and receipts arrive, changing the results of your reports.

Hence, the importance of identifying the importance of each one of them to work them according to their planned achievements, as well as to situate themselves regarding the profitability and profit of your company.

All of this, of course, without hurting your financial health. Because safe management knows how to move between the past and the present to achieve a stable and constantly developing future.

Help your employees work better

If liquidity indicators help companies in their decision making, corporate benefits can also help their employees to decide on their financial life more accurately.

Get to know the tool HR Consultants UKy and learn how the system that implements the on-demand payment, that is, the employees of a company can anticipate part of their wages when they need it.

This tool is changing the way employees deal with their wages and generating more job satisfaction and motivation.

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HR Consultants UKy can be one of the most valued benefits for those who work at your company. Talk to an expert and learn more!

Know, however, that you don't have to stop there. How about liking our page on Facebook and also follow us on Instagram, Twitter and LinkedIn?

There, you will get to know all of our news at first hand, and you will also learn more tips to qualitatively improve your financial management and all the management related to your business. See you there!

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