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 is not to be confused with the definition of profit and loss because NFP is expressly interested in the liquidity of the company.
A simpler way of defining NFP is the difference between an entity’s cash position and the net debt. The cash position comprises of the sum of the cash, cash at bank, savings, cash equivalents, inventory, and marketable securities. The net debt comprises of short-term and long-term claims including bank overdrafts, interest, and debt obligations.
The NFP provides business stakeholders with a unique opportunity to interrogate the business’s ability to operate smoothly in the short-term without resorting to extreme measures. The cash and cash equivalents that form the current assets should be able to sustain the current liabilities. Current liabilities are the impending obligations a business unit has to fulfill in the short-term, possibly within a financial year or within twelve months. Efficient cash flow management should be able to make funds available for meeting these obligations, providing the company with leverage because of liquidity. The liquidity of a business unit is an important metric for determining the efficiency of operations, policy and business processes in the entity.
A positive NFP portrays the company’s ability to meet its obligations using the current assets. Creditors and investors can have confidence with such a position because it shows prudent management practices, processes, and policies in the organization. A positive NFP also shows liquidity in the business and hence little desire for credit to fulfill current obligations. This avails credit lines for capital expenditure because it shows a healthy business poised for growth and expansion.
A negative NFP, on the other hand, portrays the company inability to fulfill current obligations using the current assets. Creditors and investors are weary with this position because it shows lack of prudent cash flow management. The concern, therefore, arises from the company’s management practices and businesses processes and their operational efficiency. Consequently, it shows the firm is highly likely to face a liquidity crisis. A liquidity crisis may sink the company into more debt or bankruptcy if not properly handled. In addition, a negative NFP shows investors and creditors that expansion without losing equity.
Generally, a positive NFP is an indication of a firm’s liquidity hence financial health. This acts as a cushion against adverse changes in the market, including foreign exchange fluctuation or interest rate hikes. For an investor or creditor, this is what you should be looking for as an investment with less risk. A negative NFP shows the poor financial health of the company hence high danger of losing money on such an investment.