A business unit’s net financial position (NFP) shows the difference between net working capital and the corresponding current liabilities for a specific accounting period. The NFP is special and not to be confused with the profit and loss definition, since NFP is explicitly interested in the company’s liquidity.
A simpler way to define NFP is the difference between a company’s liquidity and net debt. Cash includes the sum of cash, bank balances, savings, cash equivalents, inventories and marketable securities. Net debt includes current and non-current receivables including bank overdrafts, interest and debt obligations.
The NRP offers stakeholders a unique opportunity to question the company’s ability to function smoothly in the short term without resorting to extreme measures. The cash and cash equivalents that make up current assets should be able to support current liabilities. Current liabilities are pending obligations that a business unit has to meet in the short term, possibly within a fiscal year or within 12 months. Efficient cash flow management should be able to allocate funds to meet these obligations and give the company liquidity leverage. A business unit’s liquidity is an important metric for determining the efficiency of operations, policies, and business processes within the unit.
A positive NFP shows the company’s ability to meet its obligations using working capital. Creditors and investors can have confidence in such a position as it demonstrates prudent management practices, processes and policies in the organization. A positive NFP also indicates liquidity in the company and therefore little desire for credit to meet ongoing obligations. This leverages lines of credit for investment as it shows a healthy business poised for growth and expansion.
A negative NFP, on the other hand, indicates the company’s inability to meet current obligations with current assets. Creditors and investors are weary of this position as it demonstrates a lack of prudent cash flow management. The concern therefore stems from the company’s management practices and business processes and their operational efficiency. Consequently, this shows that there is a high probability that the company will face a liquidity crisis. A liquidity crisis can drive the company into further debt or bankruptcy if not managed properly. In addition, a negative NFP shows investors and creditors that they are expanding without losing equity.
In general, a positive NFP is an indication of a company’s liquidity and therefore its financial health. This serves as a buffer against adverse market changes, including exchange rate fluctuations or interest rate increases. For an investor or creditor, this is a less risky investment. A negative NFP shows the company’s poor financial health and thus the high risk of losing money on such an investment.