Analyzing Corporate Liquidity and Financial Health

Essential Aspects of Corporate Liquidity Analysis

There are two essential aspects in the analysis of the liquidity of a company. On one hand, there is the quality of the coverage of current debts with the most liquid assets; on the other hand, there is the temporal aspect—that is, the agility of current assets to become cash, as well as the agility of current debts to expire.

Evaluating Debt Coverage and Working Capital

In order to analyze the quality of the coverage of current debts, we start by calculating the working capital and its complementary ratios. The positive value of the working capital serves as an indicator (though never definitive evidence) of a good liquidity situation.

Liquidity Ratios: Acid Test and Cash Ratio

Due to the limitations of working capital, we have to complement the analysis with other magnitudes. In particular, the liquidity ratios are above the prudent value, indicating a good coverage of current debts. In a hypothetical scenario of maximum stress in which the company is not able to sell its stocks, the coverage of current debts is perfect (see acid test). Finally, it is observed that in the event that all the current debts expire on the closing date of the year, 30% of them could be paid (see cash ratio).

The Time Factor and Turnover Ratios

In short, the coverage of current debts with current assets is good. However, in our analysis, we should incorporate a second crucial aspect: the time factor. Given that liquidity ratios assess the coverage of current debts but not the temporal aspect, we resort to the valuation of turnover ratios and average periods.

Operating Cycles and Net Trade Cycle

We observe that the duration of the operating cycle is lower than the payment period (resulting in a negative Net Trade Cycle). This reveals a good liquidity situation because the company is able to liquidate merchandise and collect payments before the required payment date.

Conclusion and Inventory Recommendations

Our conclusion is that the company is in a good liquidity situation. Finally, it is worth highlighting that the company sells a perishable product. Given that the stock period is almost as long as the useful life of the product, we recommend an attempt to reduce the storage period.