Liquidity Analysis: Definition, Explanation & Methods
Liquidity analysis is a central part of financial management, which enables companies to secure their solvency and improve their financial stability. But how do you ensure that your own business remains solvent at all times? In this post, we'll look at what a liquidity analysis is, how it works and which methods you can use.
What is a liquidity analysis? definition
Liquidity analysis gives you a clear Financial flexibility overview your company and helps you to better understand past liquidity fluctuations and learn from them. It answers questions such as: How much liquidity did your company need in the past? Have there been periods of unexpected bottlenecks?
These insights are important in order to make adjustments at an early stage and to create a stable financial basis in the future, so that your company can pay current invoices on time and meet short-term liabilities.
A solid liquidity analysis therefore not only covers current liquidity requirements off, but allows you to Liquidity history to analyse and draw conclusions for the future. By understanding past bottlenecks, you can take the necessary measures to better cushion future fluctuations and react specifically to potential risks.
There is a distinction between two liquidity analyses, static and dynamic, which we will look at in more detail later.
Objectives of liquidity analysis
With a targeted liquidity analysis, you are pursuing several important goals that make your financial management more efficient and secure:
1. Ensure solvency
A main goal of liquidity analysis is to ensure solvency at all times. The regular analysis of liquidity figures shows you whether and when your company has enough cash to pay current invoices, salaries or supplier receivables on time. This ensures that your company remains financially flexible and is able to act at any time — an important basis for smooth business processes.
2. Identify future liquidity bottlenecks at an early stage
With a liquidity analysis, you are able to identify potential bottlenecks early on and avoid them in a targeted manner. By evaluating Cash flows and indicators, such as demands or liabilities, allow you to anticipate developments in good time and take appropriate measures before they become a challenge.
3. Learn from liquidity history
Liquidity analysis gives you valuable insights into the history. Understanding how liquidity has developed in the past and when bottlenecks occurred provides a better basis for future management to make decisions. Based on this historical data, you can better assess which liquidity reserves are required in the long term and how seasonal fluctuations or other recurring factors should be included in planning.
4. Optimize cash management
By analyzing deposits and withdrawals, you'll identify patterns and see how you can use capital more efficiently. This gives you control over your cash flow and helps free up reserves for investment and growth.
5. Improve credit rating
Good liquidity figures have a direct effect on your company's creditworthiness. A solid liquidity position and a reliable Liquidity planning increase the trust of banks, investors and other partners in your company. This allows you to negotiate better terms in the long term, whether for loans, financing or partnerships.
6. Risk management
Liquidity analysis supports the assessment and minimization of risks that could jeopardize liquidity. Examples of such risks include market fluctuations, which can drive up the costs of raw materials or services, or customer bankruptcies, which lead to payment defaults.
A liquidity analysis is not a “nice-to-have”, but a “Must-have” for your company — particularly in times of economic uncertainty. It enables strategic cash management that is specifically aimed at securing and expanding financial leeway.
The most important liquidity figures at a glance
When it comes to evaluating the financial health of your company, Liquidity ratios an important factor. These show you how well the company can meet the existing payment obligations. The most important figures for liquidity analysis include:
- Cash ratio or 1st degree liquidity
This key figure looks at immediately available means of payment in relation to short-term borrowed capital and shows how quickly your company can respond to (unforeseen) short-term payment requests. A cash ratio of at least 100 percent means that there is sufficient cash available to fully cover short-term liabilities. - Quick ratio or second-degree liquidity
In addition to means of payment, here are also short term receivables included, i.e. money that could be received soon. This key figure provides realistic insight into whether the company will remain solvent in the near future, even if it cannot immediately access liquid funds. - Current ratio or third-degree liquidity
This key figure broadens the perspective to include short-term inventories and provides a comprehensive view of the coverage of short-term liabilities.
A balanced ratio of these indicators to short-term debt capital signals financial stability and strengthens the trust of investors and partners. Find out more about the basics and communication of key liquidity figures here: Money talk — communication with and about liquidity.
Static liquidity analysis
Static analysis provides a clear snapshot of liquidity. It focuses on the liquidity ratio of your company and is often represented by the liquidity figures mentioned above (1st degree, 2nd degree and 3rd degree). With static liquidity analysis, you create a reliable basis for the financial security of your company in the present day.
It complements the long-term perspective of dynamic analysis, so that you are able to set up a comprehensive liquidity management system that keeps an eye on both short-term and long-term challenges.
Dynamic liquidity analysis
Unlike the snapshot of static analysis, dynamic liquidity analysis is based on a Long-term analysis of cash flows in the company. It gives you detailed insights into how and when liquid assets flow into and go out of your company and enables you to create a detailed liquidity plan on this basis.
A central element is the Cash flow analysis, which studies operational, investment and financing cash flows:
- Operating cash flows: These show how much money is generated or consumed from actual business activities. A positive operating cash flow is a strong signal of the financial health of your company.
- Investment cash flows: Here you can see how much money flows into fixed assets, for example in machinery, buildings or other long-term investments. The investment cash flows help you to assess how well prepared your company is for future growth.
- Financing cash flows: This area covers your company's sources of financing, such as loans or equity, and shows how much capital is available for ongoing financing.
The dynamic liquidity analysis helps you create a plan that takes into account both the current financial situation and future developments. The use of Cash flow management software Like Tidely, this process is significantly simplified. These tools automate cash flow analysis, enable real-time monitoring, and support rapid planning adjustments. In this way, your company remains flexible and prepared for upcoming challenges.
Benefits of a liquidity analysis
A thorough liquidity analysis has numerous advantages that make your company financially secure and more efficient.
1. Reducing liquidity bottlenecks
Through regular analyses, you can identify early on when bottlenecks are imminent and take timely measures to avoid them. This gives you security and strengthens your company's ability to act.
2. Optimizing invoice management
With a precise liquidity analysis, you can keep track of payment dates and payment flow. This allows you to improve your invoice management, which leads to smooth processing and less stress when settling liabilities.
3. Improving cost control
The analysis helps you to identify unnecessary spending and to reduce it in a targeted manner. This enables better control over your finances, creates financial leeway for investments and strengthens economic stability.
Effective liquidity analysis with liquidity management software
In summary, it can be stated that a transparent overview of their own liquidity is essential for companies. That's where liquidity management software comes in: With Tidely Can you precisely Liquidity analyses create and calculate your liquidity figures — simply, reliably and clearly. You can also access historical data to better understand the development of your liquidity. This allows you to see when bottlenecks have occurred in the past and how liquidity has changed over time.
In principle, liquidity analysis with Excel is also possible, but dedicated liquidity management software offers you more automation options, which reduces time, work and errors:
Tidely collects financial data from various sources automates analysis and offers up-to-date insights into liquidity. Instead of struggling through manual Excel spreadsheets and looking for abnormalities in the past, our liquidity management tool shows you the past and current liquidity situation with just a few clicks. By linking bank accounts and accounting systems, you can efficiently monitor and optimize your liquidity.
With automated processes and a clear overview, you save valuable time and minimize sources of error. Modern software helps you to effectively manage your liquidity, identify financial risks at an early stage and base your planning on solid, data-based foundations. Test Tidely today and optimize your liquidity management!
FAQ
What does liquidity mean in simple terms?
Liquidity describes the ability of a company to make payments at any time. It shows whether there are enough immediately available funds or how quickly assets can be converted into money to cover ongoing costs and liabilities.
How is liquidity determined?
Liquidity is determined by comparing your company's cash and short-term available funds with short-term liabilities. This is how you can see whether your company is able to pay all invoices due on time.
Here's how you can calculate your liquidity:
- First-degree liquidity (cash ratio) = cash equivalents: current liabilities
- 2nd degree liquidity (quick ratio) = (liquid assets + current receivables): current liabilities
- 3rd degree liquidity (current ratio) = (cash equivalents + current receivables + inventories): current liabilities
What are the three levels of liquidity?
The three levels of liquidity are:
- First-degree liquidity (cash ratio): Ratio of cash to current liabilities
- 2nd degree liquidity (quick ratio): Cash plus current receivables in relation to current liabilities
- 3rd degree liquidity (current ratio): Cash, receivables and inventories in relation to current liabilities
How do you assess liquidity?
Determine the various liquidity figures (1st degree, 2nd degree and 3rd degree) and compare the results with benchmarks and industry stocks.
- Liquidity level 1: The guideline is 0.2 to 0.5 (20% to 50%). A value of 1 (100%) shows that the company has enough liquid assets to immediately cover all current liabilities. However, too high values (e.g. 100% or more) may be inefficient as they indicate that too much capital is tied up in unproductive liquid assets.
- Liquidity level 2: Here, a value of at least 1 (100%) is considered healthy.
- Liquidity level 3: A good guideline is between 1.5 and 2.0 (150% to 200%).
