A balance sheet is a powerful tool that provides valuable insights into a company’s financial health. By comparing the assets and liabilities, you can gain a better understanding of the company’s financial standing. It gives you a clear picture of the company’s financial performance, indicating its ability to meet its short-term and long-term obligations. A well-prepared balance sheet can help investors, creditors, and other stakeholders make informed decisions about the company.
The balance sheet data will also be used to calculate the current ratio, quick ratio, and networking capital, as well as provide an explanation of each and the meaning of changes from year to year. The results can be replicated for your firm or one you are interested in investing in.
You can find tons of great articles to help you on your entrepreneurial/investing journey on the Complete Controller blog.
What is Liquidity?
If you’re running a small or medium business, one of the theories in bookkeeping that you will want to wrap your head around as timely as possible is liquidity. Liquidity measures your business’s aptitude to cover its immediate and short-term debts and responsibilities. Put differently, it’s a method of labeling how well you can shield your current liabilities using your current possessions.
Computing your company’s liquidity, which you can do by computing and tracing different ratios of your business’s properties and liabilities, will be fundamental in ensuring that your corporation is in good financial shape. It can also help you spot possible money problems before they evolve too far and help you secure loans from creditors.
Why is SME Liquidity Important?
A company needs financial freedom of action. This means you must be able to pay your bills. If you cannot pay, you’re insolvent, also called bankrupt. Liquid funds are necessary to avoid this state, which often spells the end of a company and remains solvent to pay your bills.
Even if you grow economically, solvent companies are endangered. It may be that your customers will always pay their bills. But it’s a fact that some people wait until the last moment to do it, until the very due date. Anyone not having the luxury to delay their payments but is obliged to pay immediately will have a liquidity problem if their available funds are insufficient.
Why Does it Matter to SME’s?
We’ve already seen that good liquidity—as demonstrated by healthy liquidity ratios—can help your business secure the credit it needs. But, taking a close look at your company’s liquidity over time can also allow you to make intelligent internal decisions about your business’ finances.
By comparing your current and quick ratios month-over-month and year-over-year and making comparisons to your competitors’ ratios, you increase the likelihood of spotting financial snags before they pop up or start to snowball. That way, you can make more informed decisions on company spending and determine whether or not you’ll need to liquidate any assets to cover short-term debts.
What is a Good Liquidity Ratio?
If your liquidity ratio is greater than 1, you’re doing well. There is no gold standard for a healthy liquidity ratio as it varies from market to market. It would be unreasonable to expect a construction company’s liquidity ratio to be the same as a stock broker’s.
If a company’s ratio starts climbing to a number much more significant than one, that is called a liquidity surplus. Too many assets and not enough spending hurt the market. However, if the ratio is less than one, it could spell bankruptcy for the company, indicating a struggle to pay off debts. Let’s look at some examples in the tech industry.
Conclusion
Hey there! Did you know that liquidity and liquidity risk can be a real challenge for smaller organizations? But don’t worry, with some thoughtful management, you can overcome these obstacles and keep your business thriving. In fact, prioritizing liquidity and liquidity risk management can be one of the most important steps toward a successful and vibrant global economy. So let’s get started!
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