The quote “cash is king” is true for all businesses. Each business has to invest energy and time to ensure that cash flow is free from disruptions.
The ability to pay the bills as they come is what is referred to as “liquidity.” In accordance with market conditions, the liquidity of a business is also subject to change. A good example of this is when a company moves for expansion.
Without effective corporate liquidity management, the business can be adversely affected on many fronts since liquidity is the key to the success of every business. To avoid mismanaging your assets, here are five tips to effectively manage liquidity in your business.
1. Optimize your working capital
To make sure that your business has sufficient liquidity at all times, you need to optimize your working capital. Besides identifying the ideal “liquidity-profitability” balance, as a business owner, you also have to instill cash consciousness throughout your company.
This cash conscious mindset should be introduced and practiced during staff training especially among those who deal with cash collection or disbursements.
2. Streamline cash collection
Streamlining your cash collections system is one of the most efficient ways to ensure that cash is constantly available for the business to run unimpeded. There are many areas where delays may take place; this includes the bank float, mail float and processing float.
For businesses running on limited working capital, these delays may require a new source of funds through loans which, in the future, may add further burden on the business’ available cash. Reducing the length of float periods is a great way to recover and maintain the required levels of liquidity within your business.
3. Understand optimal cash balance
Another important aspect of liquidity management is to understand your business’ optimal cash balance. You can measure liquidity using Quick ratio, Cash to Total Assets ratio, Net Liquid Balance and Current Ratio. Then again, it is also vital to know the right balance between profitability and liquidity.
Being excessively cautious may reduce the amount of available cash for investment while a liquidity shortfall may also result in a loss. You should determine the perfect balance for effective liquidity management.
4. Centralize accumulated cash
Accumulating cash in a single location from various sources is another way to optimally manage liquidity. This approach is an advantage for the business as it will have a large sum of cash to invest, which means that the investment range available is stretched or expanded.
As the owner, you will have greater control over your most liquid asset through centralized cash accumulation. Whenever cash is needed, you can immediately access it.
5. Assess overhead costs and get rid of unproductive assets
Evaluate your overhead costs and check if there are ways to decrease them. Decreasing your overhead costs can greatly impact your business’ profitability. Overhead expenses such as advertising, rent and professional fees are indirect expenditures that you acquire to operate the business outside of direct labor and material.
Assess what you have and get rid of stored assets that are unproductive. Remember that the reason you spend cash on assets such as equipment, vehicles and buildings is to produce profit. Continuously accumulating useless assets will only prove to be a liability.
Start calculating now
To protect your business, now is the right time to take a step back and look at the bigger picture, and then work out a strategy addressing the finer points of your business operations.
Below are two main financial ratios you can use to measure your company's ratio of liquidity.
- Quick ratio is equal to the current assets (less inventory) divided by your current liabilities. The target ratio should be of 1 to 2, indicating your liquid funds without bending your inventory.
- Current ratio is equal to your current assets divided by your current liabilities. The target ratio should be of 2 to 3, indicating you have the right amount of liquid funds to compensate for present obligations.
The balances of your current assets and liabilities can be found on your balance sheet. Discuss them with your accountant to assess how your business is situated financially compared to those of your competitors.
Remember that there is a thin line between liquidity and bankruptcy. Both are on a similar number line but are located on two opposing ends. Hence, it should be in the best interest of your business to properly manage cash flow to prevent liquidity from being pulled towards the side of bankruptcy.
Strict balance should be practiced because low liquidity sets bankruptcy risks. On the other hand, having extremely high liquidity indicates poor cash management.
The five ways mentioned above should be practiced by every business entity for effective liquidity management. Consult with the best business bank for further analyses and guidance to ensure that you have the proper levels of cash flow for smooth and uninterrupted company operations, and business growth.