The net financial position (NFP) of a business entity shows the difference between the net current assets and the corresponding current liabilities for a given accounting period. The NFP is special and should not be confused with the definition of profit and loss because NFP is expressly interested in the liquidity of the company.
An easier way to define NFPs is the difference between an entity’s cash position and net debt. The cash position included the sum of cash, cash in the bank, savings, cash equivalents, inventory and marketable securities. Net debt included short-term and long-term claims, including bank overdrafts, interest, and debt obligations.
The NFP provides company stakeholders with a unique opportunity to question the company’s ability to operate smoothly in the short term without resorting to extreme measures. The cash and cash equivalents that make up current assets must be able to support current liabilities. Current liabilities are the impending obligations that a business unit must meet in the short term, possibly within a financial year or within twelve months. Efficient cash flow management should allow funds to meet these obligations, providing the company with leverage due to liquidity. The liquidity of a business unit is an important metric in determining the efficiency of business operations, policies and processes in the entity.
A positive NFP portrays the ability of the company to meet its obligations using current assets. Such a position can be trusted by creditors and investors because it displays prudent management practices, processes and policies in the organization. A positive NFP also shows liquidity in the business and therefore little desire for credit to meet current obligations. This leverages capital expense lines of credit because it shows a healthy business poised for growth and expansion.
A negative NFP, on the other hand, portrays the inability of the company to meet current obligations using current assets. Creditors and investors are tired of this position because it shows a lack of prudent cash flow management. The concern, therefore, arises from the management practices and business processes of the company and its operational efficiency. Consequently, it shows that the company is very likely to face a liquidity crisis. A liquidity crisis can plunge the company into more debt or bankruptcy if not managed properly. In addition, a negative NFP shows investors and creditors that expansion without losing capital.
Generally, a positive NFP is an indication of a company’s liquidity and therefore financial health. This acts as a cushion against adverse changes in the market, including exchange rate fluctuations or increases in interest rates. For an investor or creditor, this is what you should look for as a lower risk investment. A negative NFP shows the poor financial health of the company, so there is a high risk of losing money on such investment.
