In our currently uncertain economic state, it is imperative to have a system in place to help monitor and understand your organization’s liquidity and cash management. In addition to our PowerBI Liquidity Dashboard — which helps analyze your current position and ensure your organization has real time visibility into critical metrics and key performance indicators (KPIs) — we have created this five-part thought leadership series covering topics complementary to the tools. “Business Intel” will provide insights from optimizing cash management to understanding cash movement over time.
Today’s post discusses why liquidity rations matter and how to manage your cash conversion cycle.
When it comes to cash flow, the three key liquidity ratios to wrap your arms around quickly include the current ratio, quick ratio and cash ratio. These three metrics illustrate your organization’s ability to meet its short-term debt obligations. Generally, the higher the liquidity ratio, the higher the margin of safety and probability the organization can meet its current liabilities. Liquidity ratios greater than 1 indicate your organization is in good financial health and is less likely fall into financial difficulties.
The current ratio measures whether your organization has the resources to pay its debts.
A current ratio with a value less than 1 indicates your organization may have difficulty meeting current obligations, while a value too high may indicate your organization is not using its current assets efficiently. A sound ratio gives light to the organization’s operating cycle efficiency as well as the success of management’s decision making. However, this ratio may sometimes be misleading, as slow-moving inventory, seasonality in sales or changes in inventory valuations can distort the current ratio.
Another alternative to measure liquidity is the quick ratio, which compares current liquid assets (excluding inventory) against current liabilities.
If the value of this ratio is less than 1, it indicates your organization does not have enough liquid assets to meet near-term liabilities. While the quick ratio is relatively simple and may be more representative of true liquidity, it assumes open accounts receivables will be collected, which may not be a reasonable assumption in the current environment.
The cash ratio takes your organization’s cash and cash equivalents against its short-term liabilities.
The cash ratio is considered stricter and a more conservative measure, as it solely looks at cash in determining liquidity. Creditors place more reliance on this measure, as cash alone can pay off short-term liabilities quickly, but this ratio can be a restrictive measure by which to manage a business.
If you are in a liquidity crunch, it is not too late to troubleshoot ways to produce a more optimal value.
Actions to improve your liquidity ratios include:
In addition to the three key liquidity ratios, you must monitor your cash conversion cycle to better manage cash flows through this, or any, crisis. Your cash conversion cycle equates to the time it takes to convert your resources into cash flows. As such, the shorter the cycle, the shorter the window for reinvesting that cash back into the business. The longer the cycle, the increased likelihood the cash flow may become problematic. In such a case, an organization may need to find working capital to fund both current operations as well as future growth. Techniques include maximizing the time to pay vendors, expediting the accounts receivable process and reducing expenses/improving revenues where possible.
Cohen & Co has built a PowerBI liquidity dashboard to help organizations monitor their key ratios as well as their cash conversion cycles. While these metrics offer insight into the viability and certain aspects of a business, it is important to also look at other associated measures to assess the true picture.
The PowerBI Liquidity Dashboard will allow your organization to create a data-driven culture, enabling the entire organization to make confident decisions using up-to-the minute analytics. Using this tool allows users across the business to make decisions in real time, reacting to changes in business conditions quickly. Whatever an organization’s strategic priority may be — growth, financial efficiency, innovation or sustainability — business intelligence tools provide the flexibility and customization to gain reporting visibility into key performance indicators and enable nimble decision making.
Contact John Cavalier at jcavalier@cohenco.com or a member of your service team to discuss this topic further.
Cohen & Co is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.