Series 79: Liquidity

Liquidity

In the valuation context, liquidity refers to a company’s ability to meet its short-term obligations as they fall due.

Cash flow, as stated in a company’s cash flow statement, is a basic measure of liquidity. All things being equal, a company with positive cash flow is in a better position to pay its bills than a company with negative cash flow. Cash flow itself is only part of the liquidity picture, however. For instance, cash flow indicates how much cash a company is generating but gives away nothing about how well or efficiently the company is being run.

Working capital is another figure that is an important measure of liquidity. Working capital is the amount of money a company has available to fund its operations and build its business. Working capital is calculated as follows:

working capital = current assets – current liabilities

Recall that current assets are assets that are likely to be converted into or exchanged for cash within 12 months; current liabilities are obligations the company expects to pay off within 12 months. So the working capital metric measures a company’s ability to meet its short-term financial obligations and build its business over the short-term. A company with a