The economic world must be closely linked to liquidity. Liquidity is a company’s ability to pay off existing debts or obligations. The role of liquidity is important, therefore should be carefully considered for both small and large companies. If you don’t know the liquidity of the business, then you’ll have a hard time making sure his company is running well or not. Therefore, the use of accounting systems will certainly be very helpful in avoiding human errors that often occur when calculating manually.
Do you wonder what liquidity is and how to calculate it by using a ratio? Check out the following explanation so you can see how long the company can pay for business operations and other benefits you will receive.
Table of Content
- Definition of Liquidity is
- Benefits and Functions of Liquidity are
- The Component in Liquidity is
- Calculating Liquidity Using Ratio
Definition of Liquidity is
In advance of further discussion, you must first understand what liquidity is. Liquidity is the power or ability of a company to pay short-term obligations and debts. Examples of short-term debts like taxes, business debts, dividends, and so on.
However, some would say that the definition of liquidity is that a company or an individual’s ability to pay off liabilities or debts with net assets. If the company does not have the power to pay off its obligations then it is impossible for the company to carry out the operations as previously.
In general, each company has a different level of liquidity indicated in certain numbers, such as fast ratio numbers, current ratio numbers, and cash ratio numbers. The higher the signal is that companies are performing better and better at their operations as well. High liquidity rates can attract investors such as financial institutions, creditors, and suppliers.
Also read: Examples of Ledger and How to Make It Easily
Benefits and Functions of Liquidity are
You should know that liquidity in a company has its own function and benefits to its operating process. Some of the functions and benefits include:
- As the proper media for doing day-to-day business activities.
- To be a tool of anticipation if there is an urgent or sudden need for funds.
- For companies engaged in finance, it can make it easier for customers who want to make loans or withdrawals. Companies can use the help of financial management software to optimize maximum business management.
- As a company’s flexibility level reference in obtaining investment approval or other profitable businesses.
- A tool that can trigger companies in performance repair efforts.
- As a measure of a company’s ability to pay short-term liabilities.
- Can help management in checking the work capital efficiency.
- Assist companies in analyzing and interpreting financial positions in the short term.
Therefore, maintaining liquidity is important. Because if a company maintains its, it can win both internal and external trust. With good liquidity, companies can pay employees’ salaries on a predetermined date and can easily get capital loans from Banks, investors, and others.
The Component in Liquidity is
Next thing you need to know is how to understand the liquidity component. The main components found in liquidity divide into three parts. The following are the three components:
- Density is the distance or gap which can explain price distances to a product, covering normal price distances and price-approved distances.
- Depth is a liquidity component that describes the volume of goods sold and purchased by a product at a certain price level.
- Resilience describes the rate of price change in the direction of price efficiently after price deviation or price volatility.
Calculating Liquidity Using Ratio
After learning what liquidity is and what function and benefits are, of course, you would like to know how to calculate it. To calculate that you can use the liquidity ratio, so whether the company’s liquidity is in good condition or not. These calculations divide into four types which is:
This calculation is used to identify the extent to which company fluency may offset the short-term debt. As the result shows a high value, the company’s ability to cover short-term debts increases. Here is the formula for how to calculate it to a fluent ratio:
CURRENT RATIO = CURRENT ASSETS: CURRENT DEBT
If the result is more than 1.0, then the company’s ability to pay off short-term debts is excellent. However, above 3.0, the company’s performance would be less productive. This is because fluency is not fully utilized in the form of other investments or is not exactly profit targets. Through a quick ratio, you can see if the company’s cash flow is healthy or unhealthy.
Cash is as good as how much current assets are available to pay off the company’s short-term debts. This ratio is suggested to have a comparable figure, between cash and debt to indicate 1:1. When the monetary ratio increases in cash over short-term debt, it is good, given the availability of funds to pay off the short-term obligations. Here is how we calculate the cash ratio:
CASH RATIO = CASH AND CASH EQUIVALENTS: SHORT-TERM DEBT
The intent of cash and equal cash here includes corporate cash and easily cash bearer bonds, such as bonds and mutual funds when your company needs emergency funds.
Cash turnover ratio
At this rate, you can see how many times the corporate cash is rotating in one period valued through sales. To calculate it could use the following formula:
CASH TURNOVER = NET SALES : AVERAGE CASH
If the value of the ratio is increasing, the value of the company’s financial performance increases. In addition, revolving cash indicates that the faster cash goes in the company, which means the increase in revenue so that cash for operations also activities also runs smoothly.
That is the liquidity of the company. Liquidity is the power or ability of a company to pay short-term obligations and debts. Liquidity is important because managing it means the company has made sure the company is running well. If you’re still having trouble calculating corporate liquidity, use Accounting Software from HashMicro immediately. Accounting software can be integrated with purchasing software to make it easier for you to analyze and control procurement costs. With the software from HashMicro feels easy in tax calculations, financial management, and have a calendar reminder of your debts. So that the liquidity of the company can be maintained properly. Register your company to implement the best and trusted accounting system with us!