Cash Flow Management and Financial Ratios
Cash Flow Management: Shortfalls and Surpluses
When There is a Shortfall:
- Negotiate with suppliers to delay payments.
- Accelerate the recovery of receivables.
- Conduct special promotional spot sales.
- Solicit bank loans or credit.
- Sell fixed assets that are not essential for the development of activities.
When There is a Surplus:
- Prepay bank debt to save on interest.
- Take advantage of treasury cash to buy, obtaining better prices and discounts.
- Delay customer charges to increase sales and future profits.
- Make term investments: Treasury bills, treasury notes and bonds, transfer of credit, bank debentures, and private bonds.
Cash Budget Analysis
If a given balance is above the safety limit from month X (before receivables are not secure), it would be necessary to find ways to make a permanent investment of our surplus, and the rest will find a way to invest in temporary investments, which will be confirmed according to figures provided (depending on the recovery of the effects). If it is observed that only two months, X and Y, are within the safety limits, we must find additional sources of financing which allow, albeit sparingly, to operate with some breathing space. For example, it could open a credit account in 3 months X to a month with a line of 999€ and find another alternative for the month Y.
Key Financial Ratios
Debt Ratio
Formula: Short-Term Liabilities / Total Liabilities
Analyzes the structure of the company’s debt. An ideal value is 0.5, indicating a balance between short-term and long-term debt. A higher percentage of short-term debt indicates a greater risk of insolvency and illiquidity. Conversely, more long-term debt gives the company more room to meet its obligations and conveys greater security.
Treasury Ratio
Formula: (Cash + Receivables) / Short-Term Liabilities
Measures a company’s ability to meet its short-term debts with its readily available assets. A value below X indicates potential payment suspension, while a value above X suggests excessive liquid assets.
Liquidity Ratio
Formula: (Cash + Receivables + Inventories) / Short-Term Liabilities
Measures the company’s ability to pay all short-term debts with assets that can become available in the same period. A value above X indicates idle resources that could decrease profitability, while a value below X suggests a threat of payment suspension due to low liquidity.
Solvency Ratio
Formula: Total Assets / Total Liabilities
Measures a company’s ability to meet its long-term payment obligations. The higher the ratio, the greater the security offered by the company to pay all its debts. Financial institutions consider this ratio when analyzing financing operations.
Availability Ratio
Formula: Cash / Short-Term Liabilities
Measures the company’s ability to address short-term payables using its available cash.
Autonomy Ratio
Formula: Equity / Total Liabilities
Measures a company’s ability to finance itself. It represents the relationship between the firm’s own capital and the total permanent capital necessary for financing, including medium and long-term loans and credits. A higher ratio indicates greater financial autonomy.