Liquidity Management

What is liquidity?

Liquidity is defined as the state of being liquid, or the ability to

easily turn assets or investments into cash.
More About liquidity

• In financial markets, liquidity refers to how quickly an investment

can be sold without negatively impacting its price.
• The more liquid an investment is, the more quickly it can be sold
(and vice versa), and the easier it is to sell it for fair value or
current market value.
• In accounting and financial analysis, a company’s liquidity is a
measure of how easily it can meet its short-term financial
obligations.
Liquidity of Current Assents

• Assets that have the capability of converting into cash

within a period of 12 months are considered to be
current assets, while others are treated as non-current
assets.
Current Assets : Non-Current Assets:
 Cash and cash equivalents  Long Term Investments
 Marketable Securities  Fixed Assets
 Accounts Receivable  Intangible Assets
 Inventory
 Prepaid Expenses
Liquidity Rankings

Cash Stocks (publicly traded)

Foreign Currency (FX) Commodities (physical)
Guaranteed Investment Real Estate
Certificates (GICs) Art
Government Bonds Private Businesses
Corporate Bonds
Financial liquidity

Items on a company’s balance sheet are typically

listed from the most to the least liquid.
Therefore, cash is always listed at the top of the
asset section, while other types of assets, such as
Property, Plant & Equipment (PP&E), are listed
last.
Measures of liquidity

In finance and accounting, the concept of a company’s

liquidity is its ability to meet its financial obligations.
The most common measures of liquidity are:
Current Ratio – Current assets minus current liabilities
Quick Ratio – The ratio of only the most liquid assets
(cash, accounts receivable, etc.) compared to current
liabilities
Cash Ratio – Cash on hand relative to current liabilities
Liquidity Example (Balance Sheet)
Division of Assets

Assets are separated into two categories, current assets and non-
current assets (everything else).
Current assets are as follows:
Cash
Marketable securities (These would include publicly traded stocks,
bonds, and other investments)
Inventories (Products, finished goods, raw materials, etc. that can
be sold)
Accounts receivable (Cash owed from sales to customers on credit)
Current Liabilities

Current liabilities are listed as follows:

Accounts payable (money owed to vender and
suppliers)
Accrued expenses and other (money the company
expects to owe to vendors and suppliers in the
near future)
Unearned revenue (also called deferred revenue)
Short Run Solvency

• Short term solvency ratio is used to judge the

present financial situation of a company by
calculating the assets recently used by the profit
or loss made in the business.
• It has fewer liabilities and more chances of recovering from debt
loss. It can be managed efficiently watching at the current
situation
Types of Short Term Solvency Ratios

• The different types of short term solvency ratio are –

• Current Ratio: It addresses the current debt and asset of the company.
• Acid Test Ratio: This measures the ability of the company, how
efficiently it uses its cash or asset.
• Inventory Turnover Ratio: It addresses how many times the
inventory is used or sold in a year.
• Accounts Receivable Turnover: It indicates how efficient is a
company in credit score and debt.
Advantages Of Short Term Solvency Ratio

• Financial Analysis: Short term solvency ratio is a good option,

where you can understand the capability of the company in
business. It uses only the current assets and liability pressure is
less.

• Operating Cycle: Short term solvency ratio enhances the

operation cycle of the company. It quickly converts current assets
into cash. It also helps with management efficiency.
Disadvantages of Short Term Solvency Ratio

• Inventory: Short term solvency includes inventory in the

calculation, which may lead to overestimation of the debt
obligations and thus giving a wrong ratio result.

• Standalone Failure: Short term solvency cannot withstand

with huge liabilities and often proceed to ownership change.
Long Term Solvency Ratio

• Long term solvency ratio is the total asset of the company divided
by the total liabilities or debt obligations in the market.
• Solvency Ratio = Total assets
Total Liabilities

• Long term liabilities are listed in the balance sheet, debentures,

loans, tax, and pension obligations. Long term solvency ratio may
take one year or even more to cope up with the current situation.
Types of long-term Solvency Ratios

• The different types of long term solvency ratio are –

• Debt Ratio: It measures the assets and debt obligation of a company.

• Equity Ratio: It indicates the financial ratio of the company.
• Quick Ratio: A quick ratio is similar to acid test ratio but here the
operation period is more.
• Cash Ratio: It is the ratio of income from assets and debt obligation.
Advantages of Long Term Solvency Ratio:

• Quick Cash: Long term solvency gives you the chance to quickly
convert the assets into cash. This method can be applied if you
want to profit in less time.

• Stock Exchange: The business can be grown by sharing

investments with shareholders and buying stock exchanges from
the market. Net income can be reinvested with proper tax
management.
Disadvantages of Long Term Solvency Ratio

• Liabilities: Long term solvency ratio method includes huge

liabilities as a result of debt obligations. It may increase the tax
rate and even impose subsidies on the company.

• Operation cycle: Long term solvency usually takes one year or

more than that to stable out the financial and economical error,
and manage the global market situation.
Short Term Solvency Ratios
Cash Ratio

The cash ratio is a liquidity measure that shows a company's

ability to cover its short-term obligations using only cash and cash
equivalents.
Cash Ratio = Cash + Marketable Securities
Current liabilities
Interpretation: More conservative than quick ratio as it excludes
net receivables (all of which may not be collected)
Benchmark: PG, HA, ROT (>40-50%)
 Acid Test Ratio

Acid Test Ratio= Cash+ Marketable Securities + Net

Receivables
Current liabilities
Interpretation: Immediate short-term liquidity
CFO Ratio

The operating cash flow ratio is a measure of how readily current

liabilities are covered by the cash flows generated from a
company's operations. This ratio can help gauge a company's
liquidity in the short term.

CFO ratio = CFO

Average Current Liabilities
Interpretation: Ability to repay current liabilities from operations
Inventory Turnover Ratio

• Inventory turnover is the rate at which a company

replaces inventory in a given period due to sales.
• Inventory Turnover Ratio= Cost Of Goods Sold (COGS)
Average Total Inventory
• Interpretation: Liquidity of inventory
• Benchmark: PG, HA
Days payables outstanding

Days payable outstanding (DPO) is a financial ratio that indicates

the average time (in days) that a company takes to pay its bills
and invoices to its trade creditors, which may include suppliers,
vendors, or financiers.
Average days payables outstanding = 365
Payables turnover
Average number of days until payables are paid.
Accounts Receivable Turnover

Accounts receivable turnover is described as a ratio of average

accounts receivable for a period divided by the net credit sales for that
same period. This ratio gives the business a solid idea of how efficiently
it collects on debts owed toward credit it extended, with a lower
number showing higher efficiency.
Accounts Receivable Turnover= Net Sales
Average Net Trade Receivables
Interpretation: Liquidity of receivables
Long Term Solvency Ratios
Debt Ratio

Debt Ratio: It measures the assets and debt obligation of a

company.
Debt to total assets = Total debt
Total assets
Interpretation: Percentage of total assets provided by creditors.
Total debt is a subset of total liabilities. Typically, you sum total
long term debt and the current portion of long term debt in the
numerator. Other additions might be made: notes payable, capital
leases, and operating leases if capitalized.
Equity Ratio:

Equity Ratio: It indicates the financial ratio of the company. The

equity ratio is a financial metric that measures the amount of
leverage used by a company.
Equity Ratio= Total Equity
Total Assets
Interpretation: Equity ratio uses a company’s total assets (current
and non-current) and total equity to help indicate how leveraged
the company is: how effectively they fund asset requirements
without using debt.
Cash Ratio

Cash Ratio: It is the ratio of income from assets and debt

obligation.
Cash ratio = Cash + Marketable Securities
Current liabilities
Interpretation: More conservative than quick ratio as it excludes
net receivables (all of which may not be collected)
Net Trade Cycle

Net Trade Cycle Or Cash Cycle = Operating

Cycle - Average Days Payables Outstanding
Interpretation: Indicates the days in the normal cash conversion
cycle of the firm.
What is a Collection Period?

A collection period is the average number of days required to collect

receivables from customers.
It is measured as the interval from the issuance of an invoice to the
receipt of cash from the customer.
A shorter collection period is considered optimal, since the creditor
entity has its funds at risk for a shorter period of time, and also needs
less working capital to run the business. \
However, some entities deliberately allow a longer collection period
in order to expand their sales to customers having lower credit
quality.
Days Inventory Held

Days inventory outstanding (DIO) is a working capital management ratio that

measures the average number of days that a company holds inventory for
before turning it into sales.
Inventory days = 365 / Inventory turnover.
Inventory turnover = Cost of products sold/Inventory.
Inventory days = 365 x Average inventory.
Interpretation: Average number of days inventory held until sold.
The lower the figure, the shorter the period that cash is tied up in
inventory and the lower the risk that stock will become obsolete.
Advantages of Liquidity

This displays the company’s ability to turn assets into cash.

It bifurcates more liquid assets from less liquid assets with their true values.
It gives lenders and buyers a clear view of the organization. The liquidity
ratio of the business will portray to the creditors and investors how much
financially strong the company is.
It helps in decision making as when your company’s liquidity ratio is
monitored timely; management will be in a better position to make quality
decisions that will help you to gain more profits and growth.
Liquidity order helps in times of emergencies by providing quick funds to
overcome the scenario that is being faced by the organization.
Disadvantages of Liquidity

Different accounting GAAPs may provide different listing criteria, and

thus, the company’s financial position comparability gets affected.
Liquidity listing of assets may not always be useful for each and every
stakeholder like investors who wish to invest for the long-term period
will be least bothered about the current liquidity position of the
company.
Certain assets like prepaid and deferred expenses may not find an
adequate position as per listing criteria as these will never be realized
in cash, but these are current assets because services against
payment processed are yet to be utilized.
Debt Management
What is Debt Management?

Definition: Debt management is a way

to get your debt under control through
financial planning and budgeting.
The goal of a debt management plan is to use these strategies to
help you lower your current debt and move toward eliminating it
completely.
Credit and Store Cards

Using these to pay living expenses can be

inefficient if the outstanding balance isn’t paid in
full within the interest free period (usually
monthly).
Interest charges are generally significantly higher
than for other loans, making any ‘cheap’
purchases potentially expensive.
Personal loans

Using a personal loan to buy a car or boat isn’t

efficient.
These assets don’t produce any income and the
interest incurred usually isn’t tax deductible.
The interest rate is also typically higher than
that for loans secured against real property.
Home Loans

Although residential property generally

increases in value over the long term, if the
borrower lives in the home, they aren’t
receiving income from it and they can’t
claim the interest on the loan as a tax
deduction.
Objectives Of Debt Management

1. To minimise the interest cost of servicing the debt to

the taxpayer.
2. To employ it contra-cyclically as a stabilisation
weapon to supplement monetary and fiscal policy.

• There are potential conflicts between these two objectives because they often
entail opposite policy actions. Minimising the interest cost means that during a
recession, interest rates are low. The government should exchange its maturing
securities with hew long-term securities carrying low interest rates so that their
interest cost is less in the future.
Techniques of Debt Management:

1. Lowering the Interest Cost

2. Changing the Maturity Structure
3. Advance Refunding
Amount of Debt

The total debt of a company can be found by net debt formula:

Net debt = (short-term debt + long-term debt)

- (cash + cash equivalents)
Interpretation: Add the company's short and long-term debt together
to get the total debt. To find the net debt, add the amount of cash
available in bank accounts and any cash equivalents that can be
liquidated for cash. Then subtract the cash portion from the total
debts.
Debt to Assets Ratio

The debt to asset ratio is a leverage ratio that measures the amount of
total assets that are financed by creditors instead of investors.
Debt To Total Assets = Total Debt
Total Assets
Interpretation: Percentage of total assets provided by creditors. Total
debt is a subset of total liabilities. Typically, you sum total long term
debt and the current portion of long term debt in the numerator. Other
additions might be made: notes payable, capital leases, and operating
leases if capitalized.
Debt to Equity

The debt-to-equity (D/E) ratio is used to evaluate a company's

financial leverage and is calculated by dividing a company's total
liabilities by its shareholder equity
Debt to equity = Total debt
Total shareholders’ equity
Interpretation: Percentage of total assets provided by owners.
Long Term Debt To Total Capital

The long-term debt to capitalization ratio, a variation of the

traditional debt-to-equity (D/E) ratio, shows the financial leverage
of a firm. It is calculated by dividing long-term debt by total
available capital (long-term debt, preferred stock, and common
stock).
Long-term Debt to Capital= Long-term Debt
Total Capital
Interpretation: Investors compare the financial leverage of firms to
analyze the associated investment risk.
Coverage of Debt

• The debt coverage ratio is used in banking to determine a

companies ability to generate enough income in its
operations to cover the expense of a debt.
• Debt Coverage Ratio= Net Operating Income
• Debt Service
• Interpretation: A company's net operating income is its revenues
minus its operating expenses. For comparison, a company's net
income considers interest expenses on debt, taxes, and income not
earned in its natural operations.
Times Interest Earned

The times interest earned (TIE) ratio is a measure of a company's

ability to meet its debt obligations based on its current income.
Times interest earned (TIE) = EBIT
Interest expense
Interpretation: Ability to meet interest payments as they mature.
EBIT is sometimes called Operating Income.
CFO to Interest

Ability to meet interest payments from operating cash flow.

CFO to interest = CFO + Interest And Taxes Paid In Cash
Interest Expense
Interpretation: Some analysts calculate the numerator using CFO +
interest expense + tax expense. This calculation is less internally
consistent as what we are striving for in the numerator is a cash
flow number, not a mix of cash flow and accruals.
CFO to Debt

Cash flow to debt ratio as the name suggests compares the total cash
flow to total debt due by the company. The ratio tells about the debt-
paying capacity of a company.
CFO to debt = CFO + Interest And Taxes Paid In Cash
Average total liabilities
Interpretation: Ability to repay total liabilities in a given year from
operations. See caveat above regarding numerator.
 Cash Flow Adequacy

The cash flow adequacy ratio measures whether the cash generated by a
company's operations are enough to pay for its other expenses that are
likely to be ongoing for example, any fixed asset acquisitions or dividends
to shareholders.
Cash Flow Adequacy = CFO
CAPEX + debt and dividends payments
Interpretation: Measures how many times capital expenditures, debt
repayments, cash dividends covered by CFO.
 Advantages of a Debt Management

 Quick To Implement
A DMP allows you to start making reduced payments to your debts immediately. The payments
you make next month could be your first DMP payments putting you straight back in control of
your money. Collection letters and phone calls from your creditors will take 2-3 months to
reduce.
 Private Solution
Because it is an informal solution, anyone can start a DMP. There is no formal register of DMPs
and no-one other than your creditors will know about the agreement. For this reason starting a
DMP is very unlikely to affect your job.
 Flexibility
Once you have started a DMP, you can increase your payments at any time if your situation
improves or even pay off your debt in full if you get a windfall. In addition it is possible to
leave creditors out of the plan or even pay off one before another.
Disadvantages of a Debt Management 

1. Extended repayment period

2. Your living expenses will be restricted
3. Only Unsecured debts are included
4. Interest and charges not frozen
5. No legal protection from creditors
6. Negative effect on credit rating
Thank You!