🔍 What is liquidity?
Liquidity measures a company’s ability to meet its short-term financial obligations using its available assets. It reflects the capacity of a business to convert assets into cash quickly without significant loss of value, ensuring it can pay debts and commitments when they come due.
💡 Why is it important?
Ensures the company can honor obligations without selling long-term assets or relying on emergency financing.
Directly impacts the company’s financial stability and credibility with creditors.
A strong liquidity position allows for greater operational flexibility and confidence in business continuity.
🎯 Desired range or level
The liquidity ratio should generally be greater than 1, indicating that current assets are sufficient to cover current liabilities.
The optimal level can vary depending on:
Industry norms
Business models
Operational strategies
📊 Key Indicators
Liquidity Ratio
🔍 What is it?
Measures a company’s ability to pay short-term debts using current assets. It compares assets that can be converted to cash within a year (such as cash, accounts receivable, inventories) to liabilities due within the same period.
💡 Why is it important?
A key indicator of short-term financial health:
A low ratio may indicate difficulty in meeting immediate obligations.
A high ratio may suggest inefficient use of assets or excess idle resources.
🎯 Target range
Generally, a ratio of 1:1 or higher is considered healthy, meaning there is at least one unit of current assets for every unit of current liabilities. However, the ideal range varies by sector and business model, so comparison with industry standards is important.
🔣 Formula
Liquidity Ratio = Current Assets / Current Liabilities
Debt Ratio
🔍 What is it?
Indicates the proportion of a company’s total assets financed through debt. It is a measure of financial leverage and solvency risk.
💡 Why is it important?
Helps assess the company’s long-term financial stability.
A high ratio can signal greater financial risk if the company is unable to generate sufficient revenue to cover obligations.
Debt can enhance returns when managed well, but excessive debt increases vulnerability.
🎯 Target range
Varies by industry and growth stage. Very high ratios may be a warning sign for investors and creditors. It’s essential to compare with similar companies in the same sector to assess appropriateness.
🔣 Formula
Debt Ratio = Total Debt / Total Assets
✅ Actions to Improve Liquidity
Reduce the credit term granted to customers to accelerate cash inflows.
Manage inventory efficiently to avoid excess stock and free up cash.
Renegotiate payment terms with suppliers to extend payment deadlines.
Seek alternative short-term financing options to strengthen cash reserves.