Factoring is an alternative for companies to outsource the management of invoice collection with their customersTo effectively manage a company, one of the most important issues to take into account is the optimization of available assets, among which liquidity is one of the most important.
The liquidity of a company is made up of the assets that enable it to meet its short-term obligations. The liquidity ratio is the formula which, taking into account the expenses to be borne by the business, is used to calculate this capacity to meet these payments.
To calculate the liquidity ratio, current assets (short-term receivables or realizable assets, plus cash and inventories) are divided by current liabilities (payments to be made by the company in the near future).
Let's take the example of a bakery that has 4,000 euros in cash, 500 euros in stock and a total of 700 euros receivable in outstanding invoices. However, it also has 500 euros in flour and other purchased products pending payment and a total of 3,000 euros in rent and tax expenses, making a total of 3,500 euros in current liabilities, so that the liquidity ratio is approximately 1.5 (5,200 / 3,500).
In this case the liquidity ratio would be optimal. A result equal to or greater than one means a good liquidity ratio, which indicates that the company has a good balance sheet that allows it to meet its most immediate obligations, while a liquidity ratio that is too high indicates that resources that could be invested (in the same business for example) to obtain a higher profitability are being wasted.
On the other hand, a liquidity ratio of less than one indicates that the company may be in difficulty to meet its payments, so it would be advisable to consider the idea of resorting to some type of financing to obtain liquidity.
Nowadays there are alternative methods to bank loans to obtain it. Those under the alternative financing brand, such as factoring and confirming, are experiencing a considerable boom in recent months due to their versatility and agility.
Immediate liquidity ratio
To make a more demanding calculation of the business's ability to meet its payment commitments, companies use the so-called immediate liquidity ratio. In this case, only immediately available assets are taken into account: cash.
Immediate Liquidity Ratio = Cash on Hand / Current Liabilities
This is an indicator that reflects the cash flow's capacity to meet imminent payments and, therefore, a very low value in this ratio should set off alarm bells.
A low immediate liquidity ratio will eventually lead to payment delays and creditor distrust, which could close sources of financing and cause financial asphyxiation, jeopardizing the continuity of the business.
In order to have a strong cash flow, it is of great help to shorten the collection times of outstanding invoices and one of the most efficient methods to do so is by outsourcing them with services such as factoring, which involves the assignment of invoice collection rights to a third party company in exchange for financing.
