How to build a liquidity position report

Cash flow challenges don't just threaten businesses—they can extinguish them faster than product failures. Without visibility into your true cash position, you're essentially navigating blindfolded.

Good liquidity planning and management begins with generating a liquidity position report. In this guide, you’ll learn how to build a liquidity position report that helps you stay ahead of the curve and mitigate financial risks in your business.

What is a liquidity position report?

Liquidity position reports are comprehensive financial documents that provide a detailed snapshot of an organization's ability to meet its cash and collateral obligations. Understanding financial liquidity is crucial because at its core, a liquidity position report measures a financial institution's ability to convert assets into cash efficiently and at a reasonable cost.

These reports play a vital role in maintaining financial stability by helping organizations monitor their liquidity risks and ensure they have sufficient funds to meet short-term obligations.

Liquidity is not static but rather a dynamic condition influenced by various factors including market conditions, economic variables, and exposure to credit, market, operational, legal, and reputational risks. Understanding this dynamic nature is essential for effective liquidity management.

Types of liquidity

To fully grasp how to build a liquidity position report, it's important to understand the different types of liquidity it may address:

• Asset liquidity: This refers to how quickly and easily an asset can be converted into cash without significant loss of value. Cash on hand and investments in short-term debt instruments are considered highly liquid assets that can be readily accessed when needed, highlighting the importance of liquid assets.
• Market liquidity: This describes the ease with which assets can be bought or sold in the market without causing significant price movements. Markets with high liquidity have many buyers and sellers, creating relatively stable prices and efficient transactions.
• Accounting liquidity: This measures a company's ability to meet its day-to-day operational expenses, such as payroll and inventory costs. It's arguably the most critical type of liquidity as it directly impacts a company's short-term solvency and operational continuity.

Static vs. dynamic liquidity

Liquidity position reports often address both static and dynamic aspects of liquidity:

• Static Liquidity: This approach indicates whether a company can satisfy its payment obligations using its current assets. It provides a point-in-time assessment of immediate assets available to cover short-term liabilities, essentially offering a snapshot of the organization's liquidity position.
• Dynamic Liquidity: Unlike static measures, dynamic liquidity evaluates the ratio of a company's cash flows—both incoming and outgoing—over time. This provides a more comprehensive view of liquidity, accounting for the timing of cash flows and offering insights into future liquidity positions rather than just the current state.

This distinction is crucial because while static liquidity might show a healthy position at a specific moment, dynamic liquidity can reveal potential future shortfalls that need to be addressed proactively.

The most effective liquidity position reports incorporate both perspectives to provide a complete picture of an organization's liquidity health.

Key components of a liquidity position report

A comprehensive liquidity position report contains several critical elements that work together to provide a complete picture of your organization's financial health and cash management capabilities.

• Liquidity needs and sources of funds: This component outlines cash flow requirements and available resources across various time horizons and scenarios. Often presented as pro forma cash flow reports or scenario analyses, these projections help organizations anticipate funding gaps and plan accordingly for both normal operations and stress conditions.
• Available funds and highly liquid assets: This section details the organization's immediately accessible funds and assets that can be quickly converted to cash with minimal value loss. The inventory of readily available resources provides a clear picture of the organization's capacity to address immediate liquidity demands without relying on external funding sources, thereby enhancing spend visibility.
• Collateral positions: This element catalogs both pledged and unpledged assets, along with availability by legal entity, jurisdiction, and currency exposure. Tracking collateral is crucial as it affects an organization's ability to secure additional funding when needed and helps identify potential constraints on liquidity during stressed conditions.
• Funding categories and concentrations: This component breaks down funding sources by type, maturity, and stability, highlighting areas of concentration risk. Excessive reliance on a single funding source or category can create vulnerabilities, so this analysis helps ensure appropriate diversification of funding structures.
• Compliance with policy risk limits: This component tracks adherence to internal policies regarding liquidity management and notes any exceptions. Monitoring policy compliance helps ensure the organization operates within its established risk appetite and identifies areas where limits may need adjustment.
• Liquidity ratios: This section includes key financial metrics such as current ratio, quick ratio, and cash ratio that provide standardized measures of liquidity health. These liquidity ratio calculations offer a quantitative assessment of the organization's ability to meet short-term obligations and facilitate comparison with industry benchmarks and historical performance.
• Early warning indicators: This component tracks signals that might indicate emerging liquidity pressures or contingency funding events. These indicators serve as a monitoring system that allows management to respond proactively to deteriorating conditions before they escalate into serious liquidity challenges.
• Stress test results: This element presents outcomes from various stress scenarios designed to test the organization's liquidity resilience. These tests assess how well the organization can withstand adverse market conditions, significant withdrawals, or other stressful events that could impact liquidity.

The frequency and detail of liquidity position reports may vary based on the organization's complexity and risk profile. Daily reports are common for personnel directly involved in liquidity management, while senior management may review them weekly or monthly.

Step-by-step guide: how to build a liquidity position report

The following steps will guide you through the process of building a report that not only tracks your current position but also helps forecast future liquidity needs.

1. Gather financial statements

Consider your balance sheet the foundation of your liquidity architecture. Without it, building a reliable liquidity position report is impossible.

Begin by collecting your current and historical balance sheets, focusing particularly on the details of your current assets (cash, receivables, inventory) and current liabilities (payables, accrued expenses). These figures aren't just numbers—they tell your business's financial story.

Remember that the quality of your liquidity position report depends entirely on the accuracy of this financial data. Working with precise, up-to-date statements is essential before moving to the next steps.

2. Calculate key liquidity ratios

Now transform those raw numbers into meaningful insights by calculating three key ratios that illuminate different aspects of your liquidity:

• Current Ratio: Current Assets ÷ Current Liabilities. This provides a comprehensive view of your ability to cover short-term obligations.
• Quick Ratio: (Current Assets - Inventory) ÷ Current Liabilities. This offers a more conservative assessment by excluding inventory.
• Cash Ratio: Cash and Cash Equivalents ÷ Current Liabilities. This focuses solely on your most liquid assets.

These calculations serve as diagnostic tools that reveal distinct dimensions of your financial health.

3. Analyze ratio results

Numbers need context to become meaningful. Interpreting what your ratio calculations signify for your business is crucial.

A current ratio of 1 indicates you have just enough current assets to cover your current liabilities. Below 1 suggests potential challenges ahead, while above 2 or 3 indicates solid financial footing.

Interestingly, extremely high ratios (like 8.5) might actually signal inefficiency. You may be sitting on resources that could be better deployed to grow your business.

Compare your results against industry benchmarks and your historical performance to guide your financial strategy.

4. Incorporate cash flow projections

While balance sheet ratios provide today's snapshot, cash flow projections let you anticipate what's coming by employing cash flow forecasting techniques. They transform your liquidity position report from a static document into a dynamic forecasting tool.

Review recent cash flow statements to understand how money moves through your business, then develop realistic projections for the next 6-12 months based on expected inflows and outflows, considering both short-term and long-term cash flow forecasting.

Be sure to account for seasonality, planned capital expenses, debt payments, and potential market shifts. This forward-looking analysis helps you identify potential cash constraints before they materialize, giving you time to adjust rather than react.

5. Benchmark against industry peers

Understanding how your liquidity metrics compare to competitors provides essential context for financial decision-making.

Gather liquidity data from industry peers or reports to establish relevant benchmarks. Consider whether your liquidity challenges are unique to your company or reflect industry-wide patterns.

If your liquidity ratios fall below industry averages, investigate deeper. The issue might lie in your operations, cash management practices, or debt structure. This comparative analysis elevates your liquidity position report from an internal document to a strategic positioning tool.

Liquidity ratios and metrics

Liquidity ratios and metrics provide essential insights into an organization's financial health and ability to meet short-term obligations.

Each ratio reveals a different aspect of your financial strength, helping you build a comprehensive picture of your liquidity position and identify areas for improvement.

Current ratio

The current ratio provides a broad assessment of a company's ability to cover its short-term obligations with its short-term assets, offering stakeholders a straightforward snapshot of operational solvency.

A current ratio above 1.0 indicates that a company has more current assets than current liabilities, suggesting basic short-term financial stability.

However, the current ratio's straightforward calculation can sometimes mask important nuances. While many industries consider a current ratio between 1.5 and 3.0 as healthy, optimal ratios vary significantly by sector and business model.

Companies with highly predictable cash flows might operate efficiently with lower ratios, while businesses facing greater uncertainty might require higher ratios to maintain adequate liquidity buffers.

Additionally, a sudden significant increase in the current ratio might indicate a buildup of inventory or uncollected receivables rather than improved liquidity.

Quick ratio (acid test)

The quick ratio, also known as the acid test, is a more stringent assessment of liquidity and excludes inventory from current assets before dividing by current liabilities.

This adjustment acknowledges that inventory often cannot be rapidly converted to cash without significant value loss, making the quick ratio particularly valuable for evaluating immediate liquidity. It focuses exclusively on assets that can typically be converted to cash within 90 days.

This metric provides critical insights for businesses with substantial inventory holdings or those operating in industries where inventory turnover can slow during economic downturns. A quick ratio of 1.0 or higher generally indicates that a company can meet its short-term obligations without relying on inventory sales.

For companies in volatile markets or with seasonal business cycles, monitoring variations in the quick ratio throughout the year can reveal periods of increased liquidity risk that might be obscured by the more inclusive current ratio.

Cash ratio

The cash ratio evaluates a company's ability to cover short-term obligations using only its most liquid assets, effectively answering the question: "How would we fare if all revenue stopped and payments came due immediately?" By focusing exclusively on the most liquid assets, this ratio provides the clearest picture of immediate payment capacity.

While a cash ratio of 1.0 would indicate complete coverage of short-term liabilities with cash and equivalents, most businesses operate with significantly lower cash ratios, typically between 0.2 and 0.5.

This reflects the reality that maintaining excessive cash reserves can reduce overall returns on assets. The cash ratio serves as an essential metric during financial stress scenarios or when evaluating businesses with highly unpredictable cash flows.

However, consistently high cash ratios might indicate overly conservative financial management that could be limiting growth opportunities—a consideration particularly relevant for investors evaluating capital allocation efficiency.

Net working capital

Net working capital, calculated as current assets minus current liabilities, is the capital available for day-to-day operations after satisfying short-term obligations. Unlike ratio-based metrics, net working capital provides an absolute dollar figure that directly quantifies the operational financial cushion.

This straightforward calculation makes it particularly valuable for tracking liquidity trends over time and establishing specific capital targets for different business units or subsidiaries.

The interpretation of net working capital depends significantly on company size, industry, and growth stage. A positive and growing net working capital generally indicates improving liquidity, while declining figures might signal emerging cash flow challenges.

However, extremely high working capital isn't always beneficial, as it might indicate inefficient asset utilization or suboptimal inventory management. Financial analysts often normalize this metric by expressing it as a percentage of sales or total assets to facilitate meaningful comparisons across companies of different sizes or across different periods within the same organization's history.

Days sales outstanding (DSO)

Days Sales Outstanding is the average number of days it takes a company to collect payment after making a sale, calculated by dividing accounts receivable by average daily sales. This operational metric directly affects liquidity by quantifying the efficiency of a company's collection processes and the quality of its credit policies.

Unlike traditional liquidity ratios, DSO provides specific insight into a key driver of cash flow timing rather than just the relationship between assets and liabilities at a specific moment.

Comparing a company's DSO to industry benchmarks offers valuable context for liquidity analysis, as appropriate collection periods vary significantly by business model and sector. Rising DSO figures often serve as early warning indicators of deteriorating liquidity, potentially signaling customer financial distress, inadequate collection processes, or overly lenient credit terms.

For businesses with seasonal sales patterns, tracking DSO throughout the year and comparing to corresponding periods in previous years provides more meaningful insights than annual averages. Additionally, segmenting DSO by customer type, geographic region, or product line can reveal specific areas requiring intervention to improve overall liquidity management.