Liquidity and Cash Flow

Cash convertible current assets less current liabilities define liquidity. A deficit for liquidity will call for new debt to avoid running out of cash.

View Cash Flow Examples

What follows is derived exclusively from the balance sheet.

To see how that works in action, you can view a working example of a Figurewizard balance sheet forecast, illustrating among other things how it is used to calculate liquidity and cash flow.

Working Capital and Liquidity

Current assets less current liabilities (net current assets) define working capital which in turn broadly defines liquidity.

A balance sheet with current liabilities greater then its cash convertible current assets, indicates that a business will eventually be unable to come up with the cash to pay the bills. That defines negative liquidity.

Current Assets

Cash, accounts receivable and stock / inventory are the principal liquid assets in that order of importance.

Other examples will include prepayments (e,g. insurance) and confirmed pending refunds or discounts. Loans made to directors also appear in current assets but these are often  disregarded when others are calculating your liquidity.

Current Liabilities

Fixed assets make no conrtibution to liquidity.

All debt due for payment within twelve months are charged to liquidity as current liabilities. 

Despite the fact that the net book value of fixed assets make no contribution to current assets, repayments in respect of their financing that are due within twelve months are included in current liabilities though.

The Acid Test

Also known as quick ratio; this calculates short term liquidity by ignoring the value of stock / inventory, which takes much longer to turn into cash than accounts receivable.

There may be special reasons for a deficit; for example merchandise in hand to service an imminent large order. If that is not the case however, strengthening cash flow by new capital or borrowings may be called for to maintain operating cash flow.

If cash is allowed to run out at any time during the year the result can be an unforeseen and unaddressed cash flow deficit which may well precipitate a cash flow crisis.

Failure to settle liabilities as they fall due are bound to result in a loss of confidence in a busines, which is why regular and accurate cash flow forecasting and updating as the year progresses is important. For just £30 a year, that is what Figurewizard will do.

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