Liquidity

Profit is an opinion formed over a period. Liquidity is a fact on a Tuesday. A business can be profitable, growing and solvent and still be unable to meet an obligation on the day it falls due, and the day it falls due is the only date that matters to the party owed.

How it is measured

• Current ratio: current assets over current liabilities. Crude, because it counts inventory and slow receivables as though they were cash
• Quick ratio: cash plus marketable securities plus receivables, over current liabilities. Strips inventory out and is the more honest measure for most small businesses
• Days cash on hand: cash divided by average daily operating outflow. The most intuitive number an owner can carry in their head
• Average daily balance and negative days from the bank statements, which is what short-term underwriters actually read. Two months of statements showing eight negative days say more than any ratio

Sources

Operating cash flow, undrawn committed credit, owner capital, and assets that can be converted quickly. Undrawn credit only counts if the lender is obliged to fund — an uncommitted line is not liquidity, and a facility with a material adverse change clause is liquidity that disappears when it is needed.

Why funders read behaviour, not ratios

In short-term funding nobody has audited statements. The bank statement is the liquidity report: how many days the balance ran negative, how large the average balance is relative to the proposed remittance, whether the account is swept to zero every month, and how many other funders are already taking a slice.