Investing is often done with too little thought in mind. Some people simply think that putting money into a diversified fund is going to protect them. Others feel that if they stay with blue chip investments, they will come out ahead.
But the only way to know that an investment is solid is if the company being invested in has money. After all, it’s money that pays the bills.
Performing a liquidity analysis may seem like a complex procedure, but it is nothing more than comparing a firm’s current assets to its current liabilities. If one were to do this for his household, he would compare his cash and other liquid assets to credit card balances, and other short-term debt. The assets will be divided by the liabilities, and the higher the number is, the better off the company or person is.
Locate the Company’s Balance Sheet
In order to find a company’s assets and liabilities, it is important to locate its balance sheet. For the sake of this article, a liquidity analysis is going to be performed on Delta (DAL) and JetBlue (JBLU) Airlines.
Measure Assets to Liabilities
In order to take a proper measurement of a company’s liquidity, it is important to understand that not all Current Assets are created equally.
For example, a company’s Inventory (not an issue with an airline) is not as liquid as managers would often like to believe. If it was, then they would be doing better since their products were always being converted into cash. Also, Accounts Receivable cannot be counted upon in full. For these reasons, a conservative liquidity analysis should include no inventory and only 75% of receivables.
Delta’s Balance Sheet
Delta’s Current Assets (conservatively) = $6,441,500,000
Delta’s Current Liabilities = $12,012,000,000
Delta’s Liquidity Ratio: Assets/Liabilities = .536
JetBlue’s Balance Sheet
JetBlue’s Current Assets (conservatively) = $1,442,750,000
JetBlue’s Current Liabilities = $1,296,000,000
JetBlue’s Liquidity Ratio: Assets/Liabilities = 1.11
This means that if these airlines were called upon by all of their creditors to pay on short notice, Delta would be able to come up with half of the money, and JetBlue could pay for everything, and have a small amount left over.
Liquidity Matters With Investing
While the casual observer would see that Delta has more than four times the assets of JetBlue, it is apparent that once the surface is scratched, not only does JetBlue offer more leg and arm room to its customers (as well as televisions), it also leaves more room for liquidity in its budget.
This is extremely important because recessions are usually spurred by the ripple effect of people unable to honor their payables to others. If JetBlue could not pay its creditors, such as the supplier of its tools, uniforms, and beverages, then those companies may not be able to meet their obligations. As bills go into delinquency, layoffs occur. This will lead to families who fall behind on their bills.
And just as that family would benefit from having cash, or a cash-like asset, such as JetBlue stock, so do companies that keep cash on hand, allowing themselves to pay their bills, even if they are unexpectedly called on short notice.