What is the Degree of Relative Liquidity?

The degree of relative liquidity (DRL) is a liquidity metric that examines a company's ability to support short-term expenditures. The degree of relative liquidity is determined by looking at the total percentage of cash that a company has available on hand. The cash must be earned through regular operations and able to be spent on expenditures and short-term debt obligations through a specific period.

Companies that possess a higher degree of relative liquidity will probably have less difficulty in retrieving funds for payment purposes.

Understanding the Degree of Relative Liquidity (DRL)

As with all liquidity metrics, indications that a company is barely able to make short-term payments can be a sign that the company could be facing more serious financial issues in the long term. Financial distress as a result of the inability to make debt payments could lead to bankruptcy.

The degree of relative liquidity falls in a similar financial indicator as the current ratio. Both of these measures offer an indication of the relative ease with which cash flow or assets can be used to satisfy liabilities.

Cash flow from normal operations is rather subjective in nature. Different businesses will and should recognize revenue sources differently. For example, a widget manufacturer shouldn't recognize income from ancillary sources, such as the sale of an asset, as ordinary or standard revenue. Whereas, a museum which charges admission but runs a gift shop will recognize revenues from merchandise sales as this would be considered part of a typical operating model for a museum.

This means, no two industries, and at times, even companies from the same industry, have the same revenue and expense recognition methods. Hence, it wouldn't be unusual for an analyst to adjust financial items to standardize the degree of relative liquidity ratio.

Beyond standard internal decisions, at times, such as during an economic slow spot, external factors can lead to a deterioration in financial conditions at a company — which can, in turn, weaken a business's degree of relative liquidity — even though this largely out of the control of a company's management.