Financial Liquidity – A Company Can Be Profitable and Still Have No Cash

In the previous articles, we analysed what changed in a company’s financial results, why those changes occurred, and how inflation affects comparisons between different periods. We now come to one of the most important areas of financial analysis:

financial liquidity.

A company may be increasing its sales. It may be reporting a profit. It may own substantial assets.

And yet it may still struggle to pay invoices, salaries, lease instalments or taxes.

Why?

Because profit is not the same as cash.

What is financial liquidity?

In simple terms:

financial liquidity is a company’s ability to meet its obligations when they become due.

It is therefore not enough to ask:

“Is the company profitable?”

We also need to ask:

“Does the company have the money to pay its obligations when they fall due?”

When assessing a company’s financial position, we commonly use four groups of ratios:

liquidity, profitability, debt and efficiency (turnover) ratios.

Each shows the company from a different perspective. In this article, we will focus on liquidity.

Example: the company earned one million, but there is not enough money in the bank

Suppose a company sold services worth PLN 10 million and generated a profit of PLN 1 million.

That sounds very good.

The problem is that some customers have not yet paid.

The company has:

PLN 3 million in trade receivables,

PLN 1.5 million in inventory,

PLN 500,000 in cash.

At the same time, it needs to settle PLN 4 million of current liabilities in the near future.

On paper, the company is profitable.

But some of the money needed to pay those liabilities is tied up in receivables and inventory.

This is precisely why we begin analysing liquidity ratios.

1. Current Ratio

The first basic measure is:

Current Ratio = Current Assets / Current Liabilities

Suppose:

current assets = PLN 6 million

current liabilities = PLN 4 million

6 / 4 = 1.5

This means that for every PLN 1 of short-term liabilities, the company has PLN 1.50 of current assets.

Is 1.5 a good result?

It should not be assessed mechanically. Financial literature provides various reference values, but the appropriate level depends on factors such as the industry, business model, asset turnover and payment terms.

It is far more important to observe how the ratio changes over time and to compare it with similar companies.

2. Quick Ratio – what happens when we exclude inventory?

Not all current assets are equally liquid.

Cash can be used almost immediately.

Receivables first need to be collected.

Inventory needs to be sold.

The next step is therefore the Quick Ratio, which primarily excludes inventory from current assets.

In simplified form:

Quick Ratio = (Current Assets – Inventory) / Current Liabilities

In our example:

current assets = PLN 6 million

inventory = PLN 1.5 million

current liabilities = PLN 4 million

(6 – 1.5) / 4 = 1.125

The situation may still look good.

But let us take one more step.

3. How much of our liabilities could we pay almost immediately?

Suppose the company has only:

PLN 500,000 in cash and the most liquid short-term investments.

With current liabilities of PLN 4 million:

500,000 / 4,000,000 = 0.125

This means that, at that moment, the company could cover approximately 12.5% of its current liabilities with its most liquid assets.

Now we begin to see something that profit alone did not reveal.

The company has assets.

The company has receivables.

The company has inventory.

But not all of these assets are cash available today.

A receivable is not cash

This is one of the most important principles a manager should understand.

Imagine that a company issues a customer an invoice for:

PLN 500,000 with a 60-day payment term.

The sale has been completed and the receivable appears on the balance sheet.

But the company may already need money today for fuel, salaries, social security contributions, VAT, leasing or subcontractors.

If the customer pays after 60 days, the company effectively finances that sale for two months using its own funds or external financing.

If the customer pays after 90 days, the company finances it for even longer.

This is why rapid sales growth can paradoxically worsen liquidity.

The faster you grow, the more cash you may need

Suppose a company increases its monthly sales:

from PLN 1 million to PLN 2 million.

Customers pay on average after 60 days.

The company may therefore need substantially more capital to finance the period between providing the service and receiving payment.

Growth is good.

But growth has to be financed.

The management question should therefore not be only:

“How much can we increase sales?”

It should also be:

“How much additional cash will we need to finance that growth?”

Net Working Capital – money working within the business

Another very important concept is Net Working Capital (NWC).

From an asset-based perspective:

Net Working Capital = Current Assets – Current Liabilities

If:

current assets = PLN 6 million

current liabilities = PLN 4 million,

then:

NWC = 6 – 4 = PLN 2 million

Positive net working capital means that part of the company’s current assets is financed with long-term capital.

But once again, the number alone is not enough.

We need to examine what the current assets actually consist of.

Two companies, the same ratio – completely different situations

Imagine two companies.

Both have:

PLN 6 million in current assets

and

PLN 4 million in current liabilities.

For both companies:

Current Ratio = 1.5

However, in Company A, a significant proportion of current assets consists of cash and receivables from customers who pay on time.

In Company B, a large proportion consists of difficult-to-sell inventory and overdue receivables.

Mathematically, the ratio is identical.

The liquidity risk is completely different.

This is an excellent example of why a financial ratio should never be interpreted without understanding what lies behind the number.

Liquidity is also about management

Liquidity problems are not solved simply by increasing sales.

Sometimes much more effective measures include:

* collecting receivables faster,

* shortening payment terms offered to customers,

* reducing overdue invoices,

* improving inventory management,

* negotiating payment terms with suppliers,

* appropriately matching short-term and long-term financing.

This is why liquidity is not merely an accounting issue.

It is the consequence of decisions made across sales, purchasing, logistics, operations, finance and management.

And where does cash flow fit into all this?

The balance sheet shows the company’s financial position at a specific point in time.

The cash flow statement shows where money came from during a given period and where it was spent.

This is the next level of analysis.

A company may report a profit while generating weak operating cash flows.

The opposite may also occur — the accounting result for a particular period may not look impressive, while the business generates solid cash flows.

Therefore, when assessing financial security, it is worth analysing profit, the balance sheet and cash flows together.

The most important question is not: “How much do we have?”

When analysing liquidity, several questions need to be asked simultaneously:

How much do we have in current assets?

How quickly can we convert them into cash?

When will our customers actually pay us?

When do we have to pay suppliers, employees and financial institutions?

How much cash is generated by the company’s core operations?

Only the answers to these questions reveal the real situation.

A company does not lose liquidity when an unattractive ratio appears in its financial statements.

It loses liquidity when a payment becomes due and there is no money in the bank account.

That is why a company can be profitable and still face serious financial problems.

The natural next step in this analysis is cash flow — answering the question: where did the company’s money actually go?