Liquidity indicators

Last updated: 25.03.2016

Liquidity is the entity´s ability to convert its assets into cash for the purpose to settle its obligations, ideally with the lowest possible transaction costs. (14)

 

Indicators of liquidity

Liquidity indicators show the extent to which the current assets of the company in various forms cover its short-term obligations. Thus, the number of times the entity is able to settle its current liabilities from the conversion of the current assets to cash. Therefore, it evaluates short-term financial position of the company.

 

This category includes the following basic indicators:

 

Their general interpretation:

  • lower values ​​indicate lower ability to pay short-term obligations
  • too high values may indicate inefficiencies - it is recommended to evaluate them together with turnover ratios
  • ideal values ​​shall thus be neither low nor high
  • recommended ideal values are stated within the description of each indicator individually

Comparison:

  • with the recommended values
  • however, some variations are possible by industry, type of company etc. - so it is very important to compare the indicators in time-series; it the company does not achieve the recommended values, but have done well without any problems, it can be then expected that it will continue to be successful with the same values in the future
  • appropriate is the comparison is with the industry average or with similar companies in the industry

 

Possible reasons for higher liquidity (the reasons for the lower liquidity can be applied conversely):

  • high levels of stocks (only for current liquidity)
    • this can be related to the branch (e.g. commercial companies tend to have high stock values)
    • high-quantity purchase of stocks due to favorable terms (discount), expected price increases or shortages
    • seasonal fluctuation in demand
    • stocks are overvalued - e.g. no legitimate provisions for inventories were made
    • the company holds excessive inventory. The adequacy of the level of stocks can be assessed by using indicators of activity (Inventory turnover ratio or Inventory period).
  • high receivable balances (only for current and quick liquidity ratios)
    • high receivable recorded at the end of the year, which was not paid by the end of the year
    • uncollectable debt increased
    • higher maturity provided to customers, e.g. within acquisition or retention process
    • receivables are overvalued, for example, e.g. no legitimate provisions to receivables were made
  • low payable balances, e.g. due to effective supplier management
  • economic growth, during which is the liquidity lower, because liabilities are growing faster than current assets (14)

 

Other indicators that may also be included among the indicators of liquidity:



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