Factoring is an alternative for companies to outsource the management of invoice collection with their customersTo manage a company effectively, one of the most important issues to take into account is the optimisation 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 costs to be borne by the business, is used to calculate its ability to meet these payments.
The liquidity ratio is calculated by taking current assets (short-term receivables or realisable assets, plus cash and inventories) and dividing them by current liabilities (payments to be made by the company in the near future).
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 products purchased and a total of 3,000 euros in rent and taxes pending payment, 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.
A liquidity ratio of less than one indicates that the company may be struggling to meet its payments, and it may be worth considering the idea of using some form of funding to obtain liquidity.
Nowadays there are alternative methods to bank loans to obtain it. Those under the brand name of alternative financing, such as factoring and confirming, have been experiencing a considerable boom in recent months due to their versatility and agility.
Immediate liquidity ratio
In order 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 those assets that are immediately available are taken into account: cash.
Immediate Liquidity Ratio = Cash / Current Liabilities
This is an indicator that reflects the ability of the treasury to meet imminent payments and, therefore, a very low value for this ratio should raise alarm bells.
A low immediate liquidity ratio will eventually lead to payment delays and creditor distrust, which could close off sources of funding and cause financial suffocation, threatening the continuity of the business.
In order to have a strong cash flow it is helpful to shorten the collection times of outstanding invoices and one of the most efficient methods to do this 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.
