Today more than ever, decision-making within organizations must be based on the elements they have and / or lack, know where they are standing, what their financial situation is, and in this way detect their strengths and weaknesses.
To achieve the objectives described in the previous paragraph, it is essential that companies have reliable information that reflects the reality in which they find themselves.
One of the questions that businessmen and / or managers should ask in front of business is how to synchronize money? In order to answer this question, it is necessary to understand that Finance has two main branches :
- Stock Finance , which focuses on the Stock Exchange , purchase-sale of shares, bonds, obligations, coverage and any instrument that is traded there.
- Corporate Finance , which focuses on the decisions that companies make regarding the administration of their monetary resources , treasury, collections, purchases, banks, among other topics.
The understanding of the above is very important, because when we talk about the concept of liquidity we have to position ourselves in one of the branches.
Speaking of the stock market , it is very common to hear that there is more or less liquidity in the markets , this refers to the effect that the commercialization of shares has , that is, the ease or difficulty to be able to sell or buy such instruments . When it is difficult to sell or buy, it is said that there is little liquidity, and on the contrary when the securities can be negotiated in a faster way it is said that liquidity increased or that there is liquidity.
However, in corporate finance the concept is very different, although it should be noted that there are different currents in traditional practice that today still visualize it identical, which has led many companies to make incorrect decisions in their administration, since It is believed that this concept has to do with the availability of cash that must be kept in banks . Therefore, it is necessary to define that liquidity should be understood as “the capacity that companies have to generate money in a timely manner”.
The above occurs when companies are efficient with their operation , that is, have enough money (income) at the right time, to meet their different obligations (expenses), which does not depend on the companies having reserves of money, but to have synchronicity between the money that goes in and the money that goes out.
To achieve this, it is necessary for companies to calculate the cash cycle or cash conversion cycle , which is defined as the average time the company generates money and the lower the result, the better it will be, since Indicates that the company has a greater capacity to generate flow , which will allow companies to generate more money with less investment.
In order to better understand the advantages of having a lower cycle, it must be emphasized that liquidity is a Speed Test :
Imagine for a moment that you are a car driver and that the first round of the circuit was done in 60 seconds, after this result you make some adjustments and using the same equipment you proceed to make a second attempt, at the end of the lap you realize that Now it took 30 seconds to make the same turn, this means that is faster? or slower ?, the answer is that you became faster and that the adjustments worked and if you continue like this you can go around with the same car.
This is what companies must work on, to go around with the same investment, making the necessary adjustments to be more efficient.
Traditionally, the measurement of liquidity is made through the Acid Test ; However, this test is static and does not reflect the true concept of liquidity . What this test does is to manage a hedging relationship between current assets by subtracting inventories and short-term liabilities. Its interpretation indicates ability to face debts , but that means solvency plus non-liquidity , which is why in many cases companies can show high rates with this test, but have insufficient money to meet their obligations, including payroll, the suppliers, rents, etc.
The misunderstanding of this, leads every day to make fatal decisions within the administration of companies, since to be liquid according to this test, it is required to have high levels of working capital and these should not be invested in the inventory , so then companies must work with high levels of idleness of cash and assume the costs of the inefficiency of their administration.
Therefore, it is necessary for companies to consider the difference between both reasons , the acid test measures payment capacity in a more strict manner; However, this is still solvency, and on the other hand, the so-called cash cycle measures the synchrony of companies to generate money, that is, liquidity.