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Tracking Liquidity | a Wilmington CPA says it can do more than just satisfy the bank

Wilmington NC CPA firm and tax accountant

Liquidity is just part of overall cash flow management

Cash is King; a common business adage which should be modified to Cash Flow is King.  Why?  Liquidity.  Liquidity refers to being able to pay your debts when due.  As an example, banks are proactively interested in liquidity before making a loan to a business.  One aspect of predicting liquidity uses Liquidity Ratios, explained below.  Some of the covenants banks enforce, during the term of business loans include, albeit indirectly, maintaining the Liquidity Ratios at defined levels. 

Financial ratios are derived from Financial Statement components and are a standard aspect of financial analysis.  They also form the basis of tools larger companies use to make informed managerial decisions.  A common subset of the Financial Ratios are the Liquidity Ratios.

The most common is the Current Ratio.  This is simple the company’s current assets divided by current liabilities.  The common benchmark is 1.0 (100%).  Below 1.0, current assets aren’t enough to current liabilities (debt).

For manufacturing firms, the Quick Ratio may be more relevant.  It modifies the Current Ratio by excluding Inventory from the calculation.  Why? Inventory can be hard to convert to cash within the relevant time period.

Tracking Liquidity Internally

If banks and creditors are so interested in Liquidity Ratios, doesn’t it make sense to use the concept internally as part of cash flow management?  Brilliant minds have forged managerial tools from Financial Statements over the centuries.  Yet smaller businesses, without an internal CPA or trained CFO, often don’t use them.  A shame since accounting software like QuickBooks can export reports and Financial Statements into Excel. When we build performance dashboards for our business clients, the Liquidity Ratio we use is the Operating Cash Flow Ratio.

Tracking Liquidity over Time

Financial ratios can be tracked over time.  A dual axis graph line graph is easy to maintain in Excel.  It also makes trend analysis possible, a powerful prediction tool.

Many CPAs just act as an interface between your company and the IRS.  Which is important of course.  But, if you’d like a free initial consult with a local Wilmington NC CPA who believes your QuickBooks bookkeeping and accounting should be used for more than just tax preparation, please call us at (910) 399-2705.

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