Maintaining your business’ health and pursuing its goals is one of your major obligations as a business owner. Especially when it comes to the financial aspects, no matter what size your company is. With that in mind, one of the important things you have to keep in mind is your business liquidity. You have to understand what exactly it is, and how to increase it. Because doing so will ensure your business’ financial stability and growth. So learn how to Increase Liquidity For Your Business
Liquidity is the measure of how easily an asset can be exchanged. Or basically means how quickly you can get money out of an asset. The quicker the conversion to cash of these assets, the stronger a company’s liquidity is. To better understand, here are some examples of liquid assets:
- Cash (on hand, savings account, checking account)
- Stocks and marketable securities.
- Money market funds
- Bond funds
- Mutual funds
- Accounts Receivable
- Inventory (raw materials, unsold goods, etc.)
Those assets can easily be converted to cash. Except for inventory that may or may not easily converted. For instance, in times of crisis.
Now, why is this important? Let’s just say you are trying to attract investors or incur additional debt, your company’s liquidity is the basis of its capability to pay liabilities. It is the metric of its creditworthiness and overall financial strength.
Also, failure to calculate and manage business liquidity will result in high liquidity risk. For instance, its capability to pay liabilities (bills, accounts payable, taxes, loans, etc.). Which will, later on, result in insolvency, bankruptcy, or shutting down of business, permanently. With high liquidity risks, it only means that your business has a weak cash flow control, heavy dependency on capital infusions in the form of loans, or heavy working capital tied up in inventories. So… it’s better to learn how to calculate and even increase it.
Business Liquidity Calculation
Some may say that there is no specific formula when calculating your company’s liquidity. However, by measuring it in the form of ratios, there are actually formulas. Thanks to the brilliant mind behind it, whoever that person is. Now, let’s check three of these liquidity ratios:
This is one of the easiest, and commonly used method of ratio analysis. All you need to do is use the entries from the business’ balance sheet. To be exact, you need the value of current assets and current liabilities. Here’s the formula:
- Current Ratio = Current Assets / Current Liabilities
- Quick Ratio or Acid Test Ratio
In this ratio, we have to exclude the value of your inventory as we only need most liquid assets. Here are the formulas:
- Quick Ratio = (Current Assets – Inventories) / Current Liabilities
- Quick Ratio = (Cash and Equivalents + Marketable Securities + Accounts Receivable) / Current Liabilities
- Cash Ratio
This one narrows the calculation to only the quickest assets liquidity. It means no inventory and Accounts Receivable. Here’s the formula:
- Cash Ratio = (Cash Equivalents + Marketable Securities) ÷ Current Liabilities
All of these formulas depend on higher results. Meaning if it’s 1 or higher, it means your liquidity is stable or strong. Otherwise, there’s liquidity risk. To understand it further, here’s a quick sample:
A ratio result of 2.0 means your company has $2.00 of liquid assets available to cover each $1 of current liabilities. If the ratio is 0.75 it means the liquid asset is only $0.75 to cover each $1 of current liabilities.
Tips for Increasing Liquidity
Now that we know how to check the health of the company’s liquidity, let’s check how we can improve it by following these tips:
- Lessen Overhead Expenses
Rent, marketing, and other indirect expenses are called Overhead Expenses. Those expenses get paid using the money from your cash flow. If you can reduce those expenses without sacrificing any business operation or by using an alternative way, then do it. The less you spend, the higher the liquidity of you’ll have.
- Setup and Leverage Sweep Accounts
A Sweep Accounts allows you to automatically transfer excess cash to higher interest-earning investment options or to a money market fund. This will definitely increase liquidity as these investments can be taken back quickly when needed.
- Let go of Idle Assets
Check assets that are not needed but still adds to your expenses. Especially those that are not generating revenue and idle. Let those go to free your cash flow from unnecessary expenses.
- Pay Close Attention to Your Accounts Receivable
Collecting payments in time from your clients and customers will ensure cash flow health. You may want to try giving some freebie or discount to those who can pay early. Keep in mind that the quicker you get cash and pay your bills, the healthier and stronger your liquid assets will be.
- Invest in Automation
Automation of processes and tasks will increase productivity and efficiency, at the same time, reduce expenses.
Mind that liquidity is extremely important when considering your trading positions and even your ability to exit them. Liquidity ensures you can easily get in and out of the market. Basically, liquidity should be your basis in the financial status, and growth of your business.