What is liquidity?
Simply put, liquidity is a measure of how well a company can pay off its debts without having to sell its long-term assets. It shows the ability of a company (or an individual) to pay off short-term debts, which is crucial for both financial stability and business operations.
Good liquidity not only shows that a company can survive economic challenges, but also that it is stable enough to take advantage of new opportunities without major delays. This strengthens the company's position in negotiations with suppliers and banks, which is especially important for small companies that want to establish themselves in the market.
Why is liquidity important?
Liquidity is critical to a company's operational efficiency and financial stability. In practice, this means that a company with good liquidity can manage its current payments and debts more easily without burdening day-to-day operations. It also gives the company the power to respond quickly to new business opportunities that require immediate investment.
When unexpected costs crop up, which is often the case in the business world, liquidity is what distinguishes companies that can adapt and survive from those who run into financial difficulties. That's why liquidity is considered to be the backbone of a company's financial health. With sufficient liquidity, companies can also avoid costly short-term loans when they need cash quickly.
For small companies where resources are often limited, strong liquidity can also offer a favourable position when negotiating payment terms or seeking external financing. Banks and other financial institutions look favourably at companies with good liquidity, which can result in better borrowing conditions and lower interest rates.
Keeping an eye on liquidity is therefore not only a matter of survival, but also a strategic factor for growth and development.
How do you calculate liquidity?
To understand a company's financial health, it's important to be able to measure liquidity. The two most common measures for this are the current ratio and the quick ratio.
Quick ratio
This measure provides an idea of how often a company's most liquid assets can cover its short-term liabilities. It provides a direct indication of the company's ability to manage its immediate financial liabilities.
A high value here shows that the company has good opportunities to cover its short-term liabilities quickly and efficiently.
How to calculate the quick ratio: Current assets/current liabilities
Current ratio
The current ratio goes one step further and includes more assets that can be converted into cash, providing a broader view of the company's financial stability over a longer period of time.
Here's how to calculate the current ratio: Current assets including inventories/short-term liabilities
Regularly measuring liquidity provides a clear picture of the company's financial health and its ability to withstand economic fluctuations. A company that monitors and optimizes its liquidity is better prepared for both upward and downward movements in the economy.
How do you improve your company's liquidity?
Once you've determined your company's liquidity, it's time to evaluate: is there room to improve liquidity? Here are some practical tips for strengthening your company's liquidity:
Efficient debtor management
Encourage faster payments by, for example, offering early payment discounts or implementing stricter payment terms. Automate billing processes to reduce time from sale to payment.
Optimise inventory management
Too much inventory binds capital that can otherwise be used more efficiently. Try an inventory management system to balance enough inventory to meet customer needs without overinvestment.
Negotiate payment terms
Discuss longer payment terms with suppliers to extend the time that you can keep the money in the company. At the same time, you can try to reduce your customers' payment terms.
Use credit lines wisely
Credit lines and similar bridge financing can provide the necessary breathing space for cash flow, but they must be used with a stable repayment plan to avoid high interest costs.
Leasing instead of buying
Consider leasing equipment rather than buying it. This can free up capital that would otherwise be locked up in expensive assets.
Improve cost efficiency
Review the company's costs regularly and identify areas where you can reduce or eliminate unnecessary expenses. Try investing in technology that can streamline operations and reduce costs in the long run.
View funding options
Explore various financing options that may be more cost-effective for your company's specific needs. This can range from traditional bank loans to modern financing solutions such as crowdfunding or factoring.
Make a cash flow forecast
Have an accurate and up-to-date cash flow forecast that allows you to forecast and plan periods of lower liquidity. This helps you take timely measures.
Improve your company's liquidity with Qred
Looking for a business loan? Qred offers business loans from 1,000 to 200,000 euros that can help you invest in new equipment, increase your marketing or expand your business. With a simple application process, you can get quick and easy access to capital - if everything looks good, you can even have the money in your account the same day!
Keep an eye on cash flow - the key to your company's success
Understanding and managing liquidity is critical for all small businesses striving for growth and stability. By, among other things, efficiently managing debtors, optimizing inventory management and negotiating better payment terms, the company can ensure a healthy financial basis. Remember, a proactive approach to liquidity management can make the difference between success and failure.
Ready to take your corporate finance to the next level? Get started with Qred today for financing solutions that strengthen your liquidity!
Liquidity FAQ
What is meant by liquidity?
Liquidity refers to the ability of a company or individual to quickly pay off its short-term liabilities.
What is good liquidity?
If you measure the quick ratio, it should be at or above 100% - the company must have at least enough cash (but preferably more) to cover all short-term liabilities. If you measure the current ratio, it must be at or above 200% - so the company must have twice as much cash as debt.
How do you calculate liquidity?
Liquidity is often measured by ratios such as the quick ratio and current ratio, where you divide the company's current assets by short-term liabilities to get a measure of financial health.
What is meant by a company's liquidity?
A company's liquidity is a measure of its ability to use available and easily tradable assets to service its debt, which is an important indicator of financial stability and efficiency in capital management.
