Question

discuss the concepts of liquidity, solvency and DSO's as they pertain to cash-flows and the overall health of a business.

Answer 1

Liquidity: Liquidity is a firm's ability to pay current dues. Liquidity is a measure of a technical solvency.

Liquidity can be expressed in:

- Absolute term (in $) : Current Assets - Current Liabilities = Working Capital

- Ration term : Current Ratio = Current Assets/Current Liabilities; Ideal Ratio is 2:1

Solvency: Solvency is the ability of a company to meet its long-term debts and financial obligations. Solvency is essential to staying in business as it demonstrates a company's ability to continue operations into the foreseeable future.

Example: Not able to pay the Long term debts, default on interest payments.

DSO (Days Sales Outstanding): DSO represents the average number of days to collect the credit sales made by the company.

Formula = Average Accounts Receivable/Total credit sales * No. of days in a period.

All these metric is very critical to manage the working capital for the business including to DPO.

Go through the Operating Cycle , Cash conversion cycle, DPO and DSO metric for more understanding on the cash flow of working capital.

Thank you,

Naveen