Meaning
Financial measures evaluate the ability of an enterprise to meet its short term obligations using its most liquid assets. Sufficient working capital liquidity ensures that a business can pay its suppliers and employees during the interval between paying for materials and receiving payment from customers. High levels of this metric indicate a low risk of technical insolvency.
Operational Flow
Movement of cash through the business must be fast enough to avoid a build up of debt. Maintaining working capital liquidity requires a balance between holding enough inventory to meet demand and keeping enough cash to pay the bills. If the flow slows down, the company may be forced to sell assets at a discount to raise funds.
Funding Mix
Organizations use a combination of equity and short term loans to stay liquid. A healthy working capital liquidity profile often includes a committed line of credit that can be drawn down during peak production periods. This flexibility allows the firm to take on new projects without waiting for the next customer payment.
Burn Rate
Monitoring the speed at which cash is consumed provides an early warning of potential insolvency. If working capital liquidity drops below the level needed for one month of operations, the firm is at high risk of collapse. Management must then find new equity or debt to keep the lights on.
This metric is especially important for startups where revenue has not yet reached the break even point. A company with a high burn rate and low reserves has very little time to correct its course before the funds are exhausted. This situation demands immediate and radical changes to the business model to reduce outflows.
