To Standardize or Not to Standardize Financial Liquidity Ratios? The Answer Using Financial Liquidity Efficiency of Investment Model (FLEIM)

Abstract

There is a myth about standardized financial ratios. It is believed that Current Ratio should be near to 1,5; Quick Ratio should be higher than 1; Cash Ratio should be no smaller than 0,7. Paper shows other perspective of the problem using financial liquidity efficiency of investment model (FLEIM) and Polish data for key financial liquidity indicators. Market situation influence enterprise ability to generate value for its owners depending on kind of business and individual enterprise flexibility and risk sensitivity. Enterprise financial liquidity management can reduce risk influence on enterprise results. The paper, presents the consequences that can result from operating risk that is related to liquidity policy in the context of enterprises. An increase in the level of liquid assets in an enterprise increases both net working capital requirements and the costs of holding and managing financial liquidity. Both of these decrease the value of the enterprise. But not always it works in the same way, it depends on risk sensitivity of the business which differ between branches and individual representatives from each branch. Case study data presents and is an material for discussion about general model presented in first part of the paper. The relation between liquid levels and risk sensitivity is also illustrated by empirical data from Polish firms.

Keywords: liquidity, cost of capital, firm value

JEL Classification: G32, G31, D24