A company’s current assets determine its ability to pay bills, taxes, and loans.
Liquidity allows a company to meet its financial obligations quickly without incurring additional debt, like a loan, or selling valuable assets.
When a business has more liquidity, it will be easier to raise cash quickly if there are extra expenses or unexpected losses.
There is no conversion or sale associated with cash, making it the most liquid asset of all.
In addition to these assets, other business assets include:
As investments can be converted into cash more easily, they are more liquid assets.
Assets such as equipment and premises, however, take longer to convert into cash, so they are considered less liquid.
In business, how important is liquidity?
If a company’s assets cannot generate cash quickly, it could face financial difficulties.
In the case of an unexpected loss of a high-paying customer, if the company does not have assets that can be converted into cash quickly, the company may have difficulty making up the difference. Consequently, it may have trouble paying its bills or wages.
Business insolvency can result from problems like these.
It is not uncommon for insolvent companies to sell off their most valuable assets at low prices, and even then they may be forced to declare bankruptcy and cease operations.
Taking action as a business owner
You can improve your liquidity ratio in five ways:
- Spend less on overhead. It is possible to reduce overhead costs by negotiating or shopping around for rent, utilities, and insurance. Examine your time and energy expenditures as well. When you submit and accept paper checks in your company, going digital can save you time and money.
- Get rid of unnecessary assets. Getting rid of surplus business equipment can provide a small amount of capital and reduce the cost of maintenance.
- Change the cycle of your payments. You can save hundreds to thousands of dollars if you pay your vendors early. You can also offer discounts to your customers if they submit their payments early.
- Consider a credit line. You might need a line of credit to cover cash flow gaps due to payment schedules. The first year of some business lines of credit is free, and the limit is up to $100,000 per year. Comparing terms before working with a lender is a good idea if you are considering this option.
- Review your debt obligations. The monthly payments for long-term debt can be smaller, and you will have more time to repay the balance if you switch from short-term debt to long-term debt. However, switching from long-term to short-term debt can mean higher monthly payments, but you’ll also be able to pay off your debt faster. If you plan to consolidate your debt or refinance your loans, you may be able to lower your payments now, as well as save money in the long run.
- You can earn extra revenue by using sweep accounts, which let you transfer money that isn’t needed to high-interest bank accounts