What does liquidity mean for your SME?

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What does liquidity mean for your SME?

Liquidity is a commonly used business term when discussing how the state of your business finances is doing. But what exactly is it, and why is it important for your small business? We answer both these questions below and also discuss the impact on cash flow.

 

What is liquidity?

Liquidity means the amount you will be able to pay off on outstanding debts (also referred to as liabilities) through using your current assets.

In terms of liabilities, this may be rent that is due, bank loans or outstanding utility bills.

Generally speaking, liquidity is based on liabilities and assets over a year-long period.

To have what is considered ‘healthy’ liquidity from a business perspective, you should be able to pay off any current liabilities with the assets you have.

Cash is considered as the most liquid asset, given that it can be paid off very quickly, as is the case with stocks and bonds.

However, some may take longer to convert their market value into cash, such as machinery.

Why is liquidity important?

If you have healthy liquidity this can help you maintain a strong credit score, enabling you to access the best business loans on the market.

In addition, it can also enable you to plan for the future of your company by allowing you to think about strategy and therefore make better financial decisions.

However, if you do not have good liquidity, then it may mean you will struggle to keep your company afloat if you can’t pay your bills. It also will likely reduce your ability to get access to business loans should you need one.

 

Does cash flow impact liquidity?

Yes, cash flow affects how money moves in and out of a company. As a result, knowing how healthy your cash flow is vital as this will help you to keep liquidity positive as cash is your most liquid asset.

 

How can your company improve cash flow?

Some of the main ways you can improve cash flow include:

  • Cutting out unnecessary expenses
  • Factoring your invoices
  • Leasing your equipment

Cut out unnecessary expenses

Going over your business expenses with your accountant and take a look at whether there are ways you can cut costs.  By removing any unnecessary overheads you can help to boost your cash flow.

Factoring your invoices

Invoice factoring can be an excellent way for small businesses to increase cash flow. This refers to the process of selling unpaid invoices directly to an invoice factoring company (also known as the ‘factor’).

The ‘factor’ will then pay you the majority of the invoice (approximately 85% to 90% of the overall invoice. The ‘factor’ will handle the chasing and receiving of the payment invoice. Once this has been paid the company will release the remainder of the invoice, as well as taking a small fee.

Leasing your equipment

Depending on the type of business you run, you could look at leasing the equipment you need for your business instead. This could end up saving your firm a significant amount of capital. This is because you won’t have to worry about a large-upfront cost to buy the equipment outright.