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 the NFP is expressly interested in the liquidity of the company.
A simpler way to define NFP is the difference between an entity’s cash position and net debt. The cash position is made up of the sum of cash, cash at banks, savings, cash equivalents, inventory and marketable securities. Net debt is made up of short- and long-term claims, including bank overdrafts, interest, and debt obligations.
The NFP provides the company’s 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 imminent obligations that a business unit has to meet in the short term, possibly within a fiscal year or twelve months. Efficient cash flow management must be able to make funds available to meet these obligations, providing the company with leverage due to liquidity. The liquidity of a business unit is an important metric to determine the efficiency of the operations, policies and business processes in the entity.
A positive NFP portrays the company’s ability to meet its obligations using current assets. Creditors and investors can trust 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 therefore little desire for credit to meet current obligations. This takes advantage of credit lines for capital expenditures because it shows a healthy business poised for growth and expansion.
A negative NFP, on the other hand, portrays the company’s inability to meet current obligations using current assets. Creditors and investors are weary of this position because it shows a lack of prudent cash flow management. The concern, therefore, arises from the company’s management practices and business processes 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 handled properly. Additionally, a negative NFP shows investors and creditors that expansion without losing principal.
In general, a positive NFP is an indication of a company’s liquidity and therefore its financial health. This acts as a cushion against adverse market changes, including currency fluctuations or interest rate hikes. For an investor or creditor, this is what to look for as an investment with less risk. A negative NFP shows the poor financial health of the company, hence the high risk of losing money on such an investment.