One of the factors that distinguish successful small business owners from others is their ability to stay financially liquid. They can pay their immediate obligations and maintain efficient operations every month. They have enough cash to pay their employees and contractual workers on time.
Top Reasons to Aim for Business Liquidity
What is liquidity in business and why is it important?
If you can access cash easily, your small business is liquid. High profit doesn’t necessarily mean your company is liquid. It takes time for the money generated by sales to reach your account and for you to use it for investments or paying dues.
Liquidity is important because it enables creditors to determine if you can pay debt within the terms they set. You will need credit to purchase supplies and inventory to keep your business operational and generate revenue. You’ll also need a line of credit whenever an emergency may arise and when you need to save money for future use.
Monitoring the liquidity of your small business allows you to compare any changes in your financial statements. This enables you to change your strategy, identify possible cost-cutting measures, and find ways to improve your company’s financial situation.
How Can You Tell Your Small Business is Liquid?
Cash is the main determining factor when it comes to determining a small business’ liquidity. However, you also have other assets that you can turn into cash to make your business liquid. These include accounts receivables, mutual funds, savings accounts, time deposits, some types of inventory and others. Equipment, office spaces, land and buildings take longer to liquidate even if they are assets. If you have plenty of assets you can turn into cash whenever you need them, your small business is liquid.
Liquidity Ratios to Use for Assessment
Liquidity ratios provide you with insights about the financial situation of your small business. Knowing which ratios to use allow you to implement changes and get your company back on track. Some of the ratios you might want to use include:
- Cash Ratio – you get this ratio by getting the total of cash and cash equivalents then dividing it by current liabilities. Many consider the computation for this as the purest way to gauge a small business’ liquidity because it only includes cash and cash equivalents.
- Quick Ratio – this gauges a business’ ability to pay its dues using cash, receivables, short-term investments and cash equivalents. The computation for this is adding cash, cash equivalents, accounts receivables and marketable securities then dividing it by current liabilities.
As a small business owner, monitoring liquidity is a must. If your company is liquid, you’re able to keep operations going and settle immediate dues.
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