Liquidity Analysis during COVID-19

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“Cash is king” you have heard before, but a lack of cash is inarguably the king when it comes to pushing small businesses into failure. “Running out of money is a small business’ biggest risk” – Investopedia. This stands true for companies of all sizes, and hence, the importance of proper liquidity management.

With COVID-19 and its impact on businesses, a company’s ability to generate cash from operations and factor receivables is limited. No wonder liquidity analysis is on top of CFOs’ minds.

So, what is liquidity analysis, and why now?

By the book, liquidity analysis, in corporate finance, measures a company’s ability to meet its short-term financial obligations. Very popular with investors and lenders, many companies use what is known as liquidity ratio analysis or some variety of those measures.

You can google “liquidity analysis,” and you will have more links then you can ever read. In short, the three most common, and conventional methods of analysis are:

  1. Cash Ratio, as its name implies, how much of your current liabilities are covered by your cash and cash equivalents assets.
  2. Quick Ratio, one step further than Cash Ratio, includes accounts receivable and other liquid assets.
  3. Current Ratio, includes all your existing assets, including inventory.

Different companies use some variety of these ratios based on their specific needs, but, in essence, the logic is the same.

Our advice when it comes to liquidity ratio analysis: Be honest. It’s ok to be pessimistic! The last thing you need is to take action too late. In that spirit, reassess your bad debt (historical references might not be relevant in these circumstances). Have open and honest discussions with debtors and negotiate if needed. Equally, be mindful of obsolete inventory and review your classification of short-term vs. long-term liabilities and assets (some long-term liabilities might be maturing soon and need to be included for better accuracy). Finally, run different what-if scenarios.

So, why now? Well, we are definitely not in a “business-as-usual” environment. Your revenue streams might be on pause, and they might remain so for a while even after the economy reopens. The crisis either has already impacted or will impact nearly every industry. For many companies, it is a matter of life or death to have proper liquidity risk management.

One industry that learned the lesson the hard way during the Global Financial crisis is now ahead when it comes to liquidity risk management. The banking industry leads the way in liquidity risk management governance & infrastructure and stress testing as it relates to liquidity. We all can learn and apply some concepts from these two practices.

  • Liquidity risk management addresses two risks in particular: funding liquidity risk (can a company fund its liabilities?) and market liquidity risk (can a company timely liquidate an asset to fund its liabilities).
  • Stress testing: performing sensitivity analysis of crucial liquidity metrics under stress (dramatical business scenarios)

We are ready to help

The current business environment requires change, and we are experts in change. DLC’s dedicated team of consulting professionals is here to help you navigate this dynamic landscape from revamping your business strategy to executing key finance and cash management initiatives. Check out our full suite of services here. Ready for a solution? Need some guidance? Let’s have a conversation