PLEASE NOTE: the following is an excerpt from "20 Competitive Metrics Every Business Needs to Know," which is now available as a free download here.
Performance Metric: LIQUIDITY
Definition: A MEASUREMENT OF A COMPANY'S ABILITY TO SATISFY ITS SHORT-TERM OBLIGATIONS AS AND WHEN THEY FALL DUE
Importance: From a practical standpoint, liquidity matters because a company that doesn't have enough money on hand to make payroll, cut checks to suppliers and keep its lights on can't stay in business very long. More importantly, because it's so critical to a company's on-going success, it also serves as an indirect measure of management's core competency — if a CEO or CFO can't adequately plan for the inevitable ups and downs, what else is he or she missing?
Underlying causes/influencing factors: Liquidity ratios reveal the number of times short term debt obligations are covered by cash and other liquid assets. In general, the higher the ratio the higher the margin of safety, with values of 1 to 2 indicating that the company is in good financial health and it is less likely fall into financial difficulties.
- CURRENT RATIO: current assets ÷ current liabilities
- QUICK RATIO: (current assets - inventory) ÷ current liabilities
- NET WORKING CAPITAL: current assets - current liabilities
Insight: Because most businesses can't engage in exotic forms of balance sheet alchemy, the ability to consistently control liquidity is critical. Systems and processes need to be optimized for efficiency, and risk/reward has to always be assessed in a cold, dispassionate manner.
Goal: GOLDILOCKS ZONE
Links:
HOW DEEP IS THE OCEAN? SMALL BUSINESS LIQUIDITY
MONITOR YOUR BUSINESS'S HEALTH: 3 WAYS TO TRACK LIQUIDITY
20 COMPETITIVE METRICS EVERY BUSINESS NEEDS TO KNOW
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