When liquidity is reported to small to mid-sized businesses, it is almost always reported in terms of a ratio(s)…usually the current ratio and/or quick ratio.
The problem with this is; how is a financial layman (and almost everyone else) supposed to interpret and comprehend the ratio(s)?
(FYI: liquidity and financial health are similar financial items)
The following is an example of how a business’ management is often provided liquidity information:
Example:
Management is informed that their business’ current ratio is a certain amount…let’s use 1.05:1 for this example.
Management is also informed that a traditionally healthy ratio, for their industry, is 1.50:1.
Question:
How is management supposed to relate to what this means to them, their company, its past performances, and future plans?
This rhetorical situation is used to provide the background of how liquidity is usually reported (that is when it is reported) to small to mid-sized businesses.
I ask the above question because I do not know the answer.
It is easy to understand that low ratios are bad and high ratios are good. However, how to succinctly explain to management, the extent of a problem (or on the other hand, the extent of financial strength), escapes me.
Many, if not most times, liquidity is not discussed with management until there is a significant or obvious financial health problem.
A problem with ratios → to make a point, what if sales were reported as ratios; as financial health is reported?
For example, what if sales were reported to management in the following manner:
Instead of the usual dollar amounts, suppose the current month’s sales were reported as being 1.05:1 as compared to last month’s sales.
The point being made is obvious; it is often more informative to have financial information reported in terms of dollar amounts instead of ratios.
OK then; rhetorical question...why isn’t the extremely important financial item of a business’ health reported to management in dollar amounts instead of ratios?
I suspect the reason is that a succinct and comprehensible manner to report financial health in dollar amounts has not been developed…that is at least not until now, via the Trender® Platform.
Trenders report the dollar amount of liquidity
The Trenders report liquidity in terms of a dollar amount. In addition to this actual dollar amount of liquidity, the Trenders also include a dollar amount of liquidity needed for a business of its size.
This financial insight makes evaluating adequate liquidity as easy as simple arithmetic.
Each month, all that is needed is to compare: (1) the actual dollar amount of liquidity to (2) the needed dollar amount of liquidity.
If the actual liquidity is greater than the needed liquidity, a business is liquid and well capitalized.
If the actual liquidity is less than the needed liquidity, the difference is the liquidity shortage for a liquid and strong capitalization.
Trender liquidity example…
Assume the Trender Platform calculates a business' liquidity to be $1,000,000.
The Trenders also calculate a strong liquidity for a company of this size to be $1,500,000.
Therefore, while it is easy to see that the liquidity in this example is OK (re, it is above zero, but below the target); it needs to be $500,000 stronger to equal or exceed the very financially strong target amount.
The Trenders' liquidity trends and drivers gives management the tools needed to evaluate its company’s financial health and how best to proceed with changes that it may want to make. As far as I know, these tools / insights have never been available to management.
Additionally, a liquidity graph provides a visual representation of the trends, drivers, and degree of financial health or weakness.
Conclusion: Improve and simplify the understanding of business's vitally important financial health by replacing the ambiguities of ratios with the clarity of dollar amounts.
Please reach out via the accompanying Contact sheet for more information on the Trender’s practical liquidity insights and / or commonsense financial fundamentals .