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Understanding and Calculating Liquid Funds
Understanding and Calculating Liquid Funds
Liquid funds are a company’s total financial resources that can be used at short notice to settle payment obligations.
Classic examples include:
Cash on hand (cash in the register)
Bank balances (demand deposits)
Liquid funds therefore have a major influence on a company’s solvency. If a liquidity bottleneck occurs, the risk of insolvency increases.
In Germany, payment problems and a lack of liquidity are currently more critical than ever. This is shown by figures from the Federal Statistical Office. In the first to third quarters of 2025, corporate insolvencies were more than 11.7% higher than in the same period of the previous year.
The transport and storage sectors are particularly affected, closely followed by the construction industry.
What Are Liquid Funds and Why Are They Important?
Liquid funds refer to a company’s immediately available means of payment. They can be used directly to settle debts.
In the balance sheet, they are a fixed part of current assets.
By definition, liquid funds are:
immediately available
a core term in liquidity analysis.
The term is often used synonymously with other terms. However, it is important to recognise clear differences here.
Cash funds: The definition of this term is the broader term for liquid funds. However, it is not a clearly defined balance sheet term.
Current assets: Liquid funds are part of current assets. However, the terms should not be used synonymously. This is because inventories and receivables are also part of current assets. Liquid funds are the part of current assets that can be used the fastest.
Fixed assets: These assets are tied up in the company for the long term. Examples include machinery, buildings and patents. They cannot be liquidated at short notice under any circumstances. For this reason, liquid funds are not part of fixed assets.
But what exactly belongs to liquid funds? Here we are talking about cash, also called cash on hand, and bank balances. Cheques are also part of this.
These are therefore all means of payment that are available immediately. Receivables or inventories do not have these characteristics. That is why they do not belong to liquid funds.
They play a decisive role in the annual financial statements. How liquid a company is provides a key statement about its solvency.
This key figure is central for:
creditors,
banks,
auditors.
They attach particular importance to the company being solvent.
If a bottleneck threatens here, the risk of insolvency increases. Solvency also has a direct impact on the credit rating and the going concern forecast. The meaning of liquid funds therefore plays a central role in company valuation.
Without sufficient liquid funds, even a profitable company may not be able to pay its invoices. Despite a good earnings situation, it can therefore enter a situation that threatens its existence.
How Do You Calculate Liquid Funds? Formula and Application
Liquid funds can be calculated using standardised liquidity ratios. They show how well a company can meet its short-term payment obligations.
In practice, liquid funds are divided into three liquidity levels. These range from immediate solvency, first order liquidity, to total short-term financial strength, third-order liquidity. This allows solvency to be assessed realistically from different time perspectives.
Banks, managing directors and investors use these ratios to assess a company’s situation. The liquidity ratios become especially relevant during economic uncertainty and rising insolvency risk.
First-Order Liquid Funds
This liquidity ratio is used to measure immediate solvency. Only immediately available means of payment are considered. These include:
cash on hand
bank balances
cheques
This simple calculation can be used:
The formula:
Liquidity I = Liquid funds / current liabilities × 100
The normal guideline value here is around 20 to 30%.
A value below 10% becomes concerning.
Guideline values that are too high are also risky. If the figure is above 50%, inefficient capital tied up may be possible.
Second-Order Liquid Funds
This key figure assesses short-term solvency. Short-term receivables are added to first-degree liquid funds.
The calculation is very similar to the first one and looks as follows:
Liquidity II = (Liquid funds + short-term receivables) / current liabilities × 100
The normal guideline value should always be above 100%.
Values below 100% mean dependence on incoming payments.
A very good value is reached when it exceeds 120%.
Third-degree Liquid Funds
Third-degree liquid funds measure total short-term financial strength. They therefore include total current assets. These include:
liquid funds
short-term receivables
inventories
The calculation of this liquidity ratio looks like this:
Liquidity III = Current assets / current liabilities × 100
Structural liquidity problems become clear if the calculated value is below 100%. A normal guideline value is between 120 and 200%. The limitation of this liquidity ratio is that inventories are difficult or slow to liquidate. The informative value of this key figure must therefore be assessed individually.
By looking at all three key figures together, liquid funds can be assessed realistically. This allows sound statements to be made about a company’s financial stability.
Liquid Funds in the Balance Sheet
Liquid funds are a central component of a company’s balance sheet. They provide important information about a company’s short-term solvency.
To understand where liquid funds are located in the balance sheet, we need to look at its structure. The balance sheet is divided into assets and liabilities:
Assets: Describes the use of funds.
Liabilities: Shows the source of funds.
Liquid funds in balance sheets are shown on the assets side. This is also divided into fixed assets and current assets. It is ordered by increasing liquidity.
This means:
firmly anchored land and buildings are at the top.
bank balances and cash on hand are at the bottom.
The liquid funds of current assets are at the very end of this item.
Role in the Balance Sheet
Liquid funds play a central role in the balance sheet. They reflect current readiness to pay.
This provides the basis for:
liquidity ratios
credit assessments
going concern assumptions.
If the balance of liquid funds is high, this means high security. However, it can also lead to a possibly lower return. A low balance of liquid funds can be an indicator of efficiency. But it also means an increased risk of insolvency.
Role in Liquidity Planning
Liquid funds are the starting point for every short and medium-term liquidity plan. Those who analyse and plan precisely can avoid liquidity bottlenecks and financing gaps.
Payment flows and liquidity reserves can be managed in a targeted way. This provides more security when revenue fluctuates and costs rise.
Role in the Cash Flow Statement
The assessment of liquid funds is a core objective of the cash flow statement. Payment flows are divided into three categories:
operating cash flow
investment cash flow
financing cash flow.
This makes it clear where liquid funds come from and what they are used for. The figures for this come from the balance sheet and the profit and loss statement.
The correct reporting and analysis of liquid funds are decisive. This is the only way to realistically assess financial stability, planning security and solvency.
HGB vs. IFRS: Differences in Liquid Funds
The treatment of liquid funds differs under HGB and IFRS. There are relevant differences in scope, reporting and level of detail.
IFRS takes an economic view, while HGB follows a cautious approach that protects creditors.
Aspect | HGB | IFRS |
Term | Liquid funds | Cash and cash equivalents |
Structure | Fixed balance sheet item in current assets | Located under current assets on the assets side |
Scope | Narrow definition | Broader definition |
Valuation | Principle of prudence, usually nominal value | Economic value, fair value oriented |
Reporting in the cash flow statement | Possible, but not necessarily uniform | Mandatory, clearly defined |
Notes to the financial statements | Comparatively brief | Extensive and detailed |
Examples | Cash on hand, bank balances, cheques | Additionally: short-term time deposits, money market instruments, up to 3 months |
Industry-Typical Liquidity Ratios
Healthy liquidity depends heavily on the respective industry. The differences arise from different business models, capital tied up and payment terms. To make liquidity easier to assess, we provide benchmarks. They are for guidance only and should not be seen as fixed target values.
Retail Sector
In retail, liquidity can look as follows:
Liquidity I: approx. 10 to 20%
Liquidity II: approx. 90 to 100%
Liquidity III: approx. 120 to 150%
Here, money is often tied up in inventory and cash balances are low. As long as second-degree liquidity is around 100%, this is a good sign.
Services
In the services sector, different figures can be seen. There are hardly any inventories here. Service companies are usually heavily dependent on receivable maturities. Liquidity is therefore mostly higher.
Care should be taken to ensure that it does not become unproductive. Excess liquidity should always be used as an opportunity for investment. Guidance values for services could be as follows:
Liquidity I: approx. 30 to 50%
Liquidity II: approx. 120 to 150%
Liquidity III: often > 200%
Industry
In industry, as in retail, a lot of capital is tied up in inventories. Third-degree liquidity should therefore be significantly above 100%. Guideline values could look as follows:
Liquidity I: approx. 20 to 30%
Liquidity II: approx. 100 to 120%
Liquidity III: approx. 150 to 200%
In general, a healthy company is difficult to assess at a quick glance. Instead, the individual liquidity ratios must be examined more closely. Liquidity I alone is rarely meaningful. Only when liquidity II and III are also considered can the structural robustness of a company be estimated. However, general warning signs still exist.
If the values remain permanently below the industry level, this is concerning. Liquidity ratios that fluctuate too strongly are also alarming. If there is permanently high excess liquidity, the capital should be used more efficiently.
Practical Example: Calculating Liquid Funds
Liquid funds examples clearly show how the calculation of liquid funds works in practice. They show how companies can realistically assess their short-term solvency.
Position | Amount (€) |
Cash on hand and bank balances | 25,000 |
Short-term receivables | 10,000 |
Inventories | 40,000 |
Current liabilities | 50,000 |
Based on this data, the liquidity ratios can be determined:
Liquidity 1st Degree
Liquidity I = 25,000 / 50,000 × 100 = 50%
This is very high immediate solvency. In this case, it is clearly above the usual guideline value.
Liquidity 2nd Degree
Liquidity II = (25,000 + 10,000) / 50,000 × 100 = 70%
This shows that the company depends on incoming payments arriving on time. Current liabilities are not fully covered by liquid funds and receivables.
Liquidity 3rd Degree
Liquidity III = (25,000 + 10,000 + 40,000) / 50,000 × 100 = 150%
Inventories increase liquidity in mathematical terms. However, the informative value is limited, as inventories cannot be liquidated immediately.
How Do I Practise Good Liquidity Management?
Effective liquidity management ensures that liquid funds are available at all times. At the same time, unnecessary capital tied up should be avoided. The goal is to secure solvency and maintain financial flexibility.
Here are our most important tips for managing liquid funds:
1.Regular monitoring
Ongoing control of liquid funds
Use of liquidity plans, short, medium and long term
Early identification of bottlenecks
2.Optimise payment flows
Shorten payment terms for customers
Actively use cash discounts
Negotiate supplier conditions
Manage receivables systematically
3.Define liquidity buffers
Define a minimum level of liquid funds
Use industry-specific benchmarks as guidance
Protect against revenue fluctuations and unexpected expenses
4.Secure short-term financing sources
Agree overdraft lines in good time
Check access to factoring or leasing
Prepare financing options before they are needed
5.Plan investments and expenses
Assess investments with an impact on liquidity
Manage payment timings
Prioritise according to strategic importance
6.Use digital tools and automation
Support liquidity planning with software
Use automated cash flow forecasts
Increase transparency over current and future payment flows
Summary: Why Liquid Funds Are Decisive
Liquid funds are one of the most important key figures for realistically assessing a company’s financial stability and solvency.
Liquid funds include all immediately available means of payment. With them, a company can meet ongoing obligations.
They secure solvency, influence creditworthiness and reduce the risk of insolvency.
The division into liquidity 1st, 2nd and 3rd degree enables an analysis of short-term financial performance.
Sufficient liquid funds increase crisis resilience. They protect against the risk of insolvency and provide room for action in the event of unexpected expenses.
If liquid funds are too low, acute payment bottlenecks threaten. A company therefore becomes dependent on external financing.
Excessively high liquid funds, on the other hand, are a sign of unproductive capital tied up.
The analysis of liquid funds forms the basis for structured liquidity planning. This makes active, forward-looking liquidity management possible in the best possible way.
Do you want not only to understand your liquid funds, but actively manage them?
Use Financial Navigator’s liquidity planning and analysis tools to monitor your solvency, simulate scenarios and make sound decisions based on your liquid funds. Contact our team.
Only those who regularly analyse, calculate and actively manage their liquid funds can make sound business decisions in the long term.