The purpose of the liquidity section is to measure the change in working capital of the company. In so doing, the client will have a rough estimate of whether or not they can pay the bills and how much money they will have left over.
Monitoring the company’s working capital over time will allow the firm to see:
If a company is making a profit, then the Working Capital should increase over time!
As part of the overall Flash Report, the Liquidity section ought to be monitored and reported on a periodic basis. What is that period? It is recommended that the entire Flash Report at a minimum be reviewed on a weekly basis. The more management reviews the information, the faster they can respond to crises.
The frequency of monitoring depends on several factors:
(i.e. are all A/R and Inventory entered into the system on a timely basis?)
Information for the liquidity section can be found in the Balance Sheet section of the company’s financial statements (so long as it is updated). If the firm uses a software program (i.e. PeachTree, QuickBooks, Great Plains, etc) to manage its books, then the information can be easily retrieved.
NOTE: Make sure that the ending period on the Balance Sheet matches that of the Flash Report. Both are snapshots of the company in time. Make sure we are talking about the same time period!
Review and monitor your results. Graphing the results may also be a very effective method to see what is going on in your company’s process.
In the spirit of flexibility, the Flash Report can and ought to be customized to fit each company’s needs.
The basic format is just that….a basic platform to help get you started.
For the Liquidity Section, some companies have also added the following items:
Taken together, The Cash Receipts and Cash Disbursements give an indication of whether the cash flow for the firm is positive or negative.
DSO= 365 x [Avg. A/R]/ [Total Credit Sales]
DSO tells you how many days it takes on average to collect on A/P.
DPO= 365 x [Avg A/P]/ [Total Annual Purchases]]
DPO tells you how many days it takes on average to pay your liabilities.
DIO= 365 x [Avg Inventory]/ [Cost of Goods Sold]
DIO or Inventory Turnover tells you how many days it takes on average it takes to turnover your inventory.
CCC= DSO + DIO – DPO
This tells you how many days it takes to convert raw material to cash.