Finance is a key part of running a business, be it a small-scale start-up or a large-scale company. Finance doesn’t just mean grand, innovative investments but also cash reserves for day-to-day business activities. The ability of a business to turn its current assets into cash, so it can manage its daily expenditures, such as paying its bills, wages, etc., is called liquidity. According to ACCA Global, about 82% of businesses fail not because of losses but due to poor cash flow management. It’s because this renders them unable to pay off their dues on time, pay wages, or have enough to pay for machinery maintenance, for instance.
So how do you identify whether your business is having a liquidity crisis, and what should you do to improve it? Read on to find out.
How to assess your company’s liquidity
You can use liquidity ratios to assess your business’s financial health. These are the current ratio, quick ratio, and cash ratio. In the current ratio, you take the ratio of all current assets to current liabilities. Ideally, the assets should be around twice as much as your liabilities. This signifies that you can afford to pay off all your debts and still be left with some cash. The quick ratio would exclude inventory from the assets section, as inventory is the least liquid – that is, least easily accessible – asset. This ratio should be one-to-one, showing that you readily have enough at hand to pay off your debts.
Usually, these calculations are performed by professional accountants with proper certification in accounting and finance, such as CFA, CA, or any degree that fulfills the accountant degree requirement. These individuals are trained to identify and take measures to prevent liquidity issues.
To guarantee a smooth and profitable transaction, it is wise to enlist the services of experienced professionals such as business brokers and attorneys. With careful planning and execution, selling a Tampa business can be an enjoyable and rewarding experience.
Listed below are some of the techniques with which your liquidity condition can be improved.
Remove idle assets
Long-term assets such as equipment, vehicle, machinery, etc. greatly boost productivity. However, they require maintenance and storage space, which can be costly. When these valuable assets start to falter in giving out optimum results, or worse, are sitting in your warehouses idle, they can take a toll on your liquidity. This is because a chunk of your working capital goes into maintenance when it is not contributing to your profits. Therefore, your business will benefit greatly from its sale as it will bring in extra capital that you can use daily to ease liquidity issues.
Give incentives to Accounts Receivables
It is quite likely that the Acid test or quick ratio gives you the optimal result of 1:1. However, that does not mean you are in the clear. This is because the current assets include a high value of Accounts Receivables. Then there is a chance you may not have enough cash readily available to deal with debts and expenses that come along the way. Receivables are considered one of the more difficult assets to turn liquid, so it is essential to use effective strategies to ensure quick payments. For instance, you could take a carrot-and-stick approach and offer them discounts on early payments. This should encourage them to pay sooner. However, if that doesn’t work, you could consider the stick approach by charging interest on delayed payments.
Delay payments to payables
In contrast to the point above, try to delay your obligations by talking to the suppliers to buy you more time. Usually, if your business has a good reputation with suppliers regarding timely payments, you will likely get favors and leniency. Convincing your suppliers to allow you to delay your payment will help you reduce some of your outflows long enough to recover from your receivables and other sources.
Overhead costs are your business’ indirect expenses such as rent, advertising, and professional expenses. These expenses can often be reduced or made more efficient. For instance, if your inventory turnover rate – the rate at which your inventory sells and has to be restocked – is low, you are likely to incur high storage costs. Looking into it and selling off older inventories at discounted prices, for instance, will generate more revenue and bring in cash for the business’s working capital.
Consider reducing the amount lost due to discounts by encouraging cash sales. This way, you will have money in your bank right away rather than having to wait. The only downside is that this is likely to discourage sales.
Revisit the Equity section
Take a close look at your drawings from the business. Drawing out excessively from the business will lead to cash flow issues. To discourage this, introduce interest on capital. So every time you are inclined to withdraw capital, you will have to pay your business back a higher amount in the form of interest. Of course, this interest only adds to your equity section, which will further help your business’s cash reserves. Alongside, consider introducing other finances, such as using a bank loan or a bank overdraft. This will help in the short term if there are any serious cash shortages and you need it to pay off your debts. However, this will require you to pay interest which will again increase your overheads.
Consider if you can raise prices to give your revenues a boost. With changing times and persistent inflation, increasing prices will not hurt your business if you offer good quality. Instead, it will give the added benefit of more cash inflow. Similarly, revisit your costs. With the advent of technology, it is now considerably easier to perform some mundane tasks with automation. Introducing such software might initially be quite costly. However, it will pay off in the long run with higher productivity and efficiency.
Meeting your day-to-day financial obligations is crucial for your business’s financial health. Businesses that can keep up with their payments and daily expenditures are likely to grow and succeed. It helps to constantly keep an eye on the cash flow situation of your business. Therefore, it is encouraged to draw up cash flow statements as they help identify where all the cash is going and analyze how cash flows can be optimized. With proper strategies and tools, you are sure to remain clear of any liquidity issues.