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Corporate liquidity: what it is and how to manage it

The issue of business liquidity is one of the most important topics for any business, large or small. However, many businesses face surprises and difficulties in managing money.


What is meant by corporate liquidity?

Corporate liquidity refers to a company’s ability to maintain sufficient financial assets to meet its short-term obligations.

In other words, it is the company’s ability to pay its current expenses, such as salaries, bills and supplies, without having to sell assets or take out short-term loans. Thus it indicates the availability of immediately usable financial resources that enable any kind of need or impulse to be met.

Why is liquidity important for businesses?

Boy analyzing corporate liquidity

Liquidity is a key parameter in determining the soundness of a company. This, must have sufficient financial resources available to meet its daily needs. It allows companies to cover daily expenses, such as bills and employees’ salaries. In addition, the availability of cash provides an opportunity to invest in new projects, acquire new equipment, hire new employees or expand into new markets.

Good liquidity allows you to manage financial risk, mitigating any declines in sales that could threaten your business. It also makes companies ready to seize growth opportunities, even in situations that are unforeseen or require immediate financial readiness. Finally, it is highly valued by investors and creditors, giving the company more credibility.

If a company does not have sufficient cash to cover these expenses, it may find itself in financial difficulties that lead to business crisis and even risk bankruptcy.

What is liquidity risk and when does it occur?

Risk occurs when a company does not have enough liquidity (i.e., cash or readily available cash) to cover its current expenses or to meet any unexpected expenses. In other words, the company may have trouble paying suppliers, employees, or creditors, or it may be unable to make investments needed to grow its business.

What influences liquidity risk

-Reduction in sales or loss of important customers
-Increased operating costs
-Credit management problems or late payments from customers
-Cash problems arising from excessive investment or acquisitions
-Economic crises or unforeseen market fluctuations.

Causes of the liquidity problem

There are many reasons why you may have liquidity problems.

Some of the most common causes include:

Lack of financial planning Many enterprises do not have a clear and detailed financial plan, which makes it difficult to predict future cash flows.
Wrong investmentsFirms that make the wrong or expensive investments may end up with less money available for operating expenses.
Lack of liquidityWhen you do not have a reserve of money on hand to cope with unforeseen situations.
Payment delaysLate payments from customers can have a significant impact on the company’s liquidity.
Poor accounting managementInaccurate or insufficient bookkeeping can lead to cash flow problems.

How to manage corporate liquidity

There are several strategies for managing a company’s liquidity.

The first is theadoption of sound financial policy, which requires careful cash flow management, strict credit control and medium- to long-term financial planning. It is important to maintain healthy relationships with one’s suppliers and customers, constantly monitoring payments and deadlines, and avoiding excessive dependence on one or a few customers or suppliers.

Secondly, a cost-cutting policy can be adopted, trying to cut waste that can eat into the company’s cash flow. This strategy involves constant attention to operating costs and periodic analysis of all business expenses.

One may choose to adopt an income diversification approach, seeking to expand the client portfolio by investing in new products and markets. This can ensure greater stability of the business and greater ability to generate liquidity.

In summary, corporate liquidity is a valuable asset that requires constant attention from companies. For this reason, it is essential that the company manage it carefully and wisely.

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Here are some practical tips for managing liquidity:

  • Monitor constantly -> The first step in managing corporate liquidity is to monitor it constantly. The company needs to know how much money it has on hand at any given time, both in the bank and in cash. To do this, it can use a variety of tools, such as accounting and budgeting software.
  • Prepare a budget and follow it carefully –> An accurate budget is essential for cash management. The company needs to know exactly what its financial breakeven point is and how much money it has available for investments, wages, rent and other expenses. It is important that the budget be as detailed as possible and that it be updated regularly so that prompt action can be taken in case of unforeseen changes.
  • Have a strict credit management policy -> Credit management is another important component of corporate liquidity. The company must have a strict credit policy, carefully assessing the risk of each customer before granting credit. It is also important for the company to establish clear and detailed payment terms so as to avoid late or nonpayment.
  • Making investment or divestment decisions based on liquidity -> Investment or divestment decisions should always be made with corporate liquidity in mind. The company needs to have an overview of current projects and necessary investments, carefully evaluating the costs and benefits of each project. In addition, the company must be prepared to dispose of unprofitable assets so as to maintain good liquidity.
  • Make use of appropriate financing tools -> If needed, the company can make use of various forms of financing, such as bank loans, short-term financing or lines of credit. However, it is important that these instruments be used carefully, carefully evaluating the actual cost of each option and its risks.

What are the liquidity indicators?

Liquidity ratios are tools used by companies to assess their ability to meet their debts in the short term, that is, within the next 12 months. They measure a company’s ability to quickly turn its assets into cash (liquidity) in order to meet immediate debt payment needs.

So what are corporate liquidity ratios for and what are they?

They serve as an indication of a company’s short-term solvency.

  • Current Ratio or current/secondary liquidity ratio: indicates the liquidity ratio, measuring the ratio of current assets to current liabilities. It indicates a company’s ability to cover its current debts using its current assets.
  • Quick Ratio also called the Acid Test Ratio or primary liquidity ratio: this is a financial indicator that measures a company’s ability to pay its short-term obligations without having to sell long-term assets and is given by the ratio of available assets to short-term debts

How to calculate and interpret the Current Ratio or current liquidity ratio?

Current ratio formula

A value (above 1) indicates that the company has enough cash to cover its current debts, while a low value (below 1) indicates a possible difficulty in meeting short-term payments.

However, it is important to consider that too high a value of the current ratio might suggest that the company is not investing its current assets appropriately to generate profit. In addition, the current ratio alone is not sufficient to assess the financial health of a company and should be considered in conjunction with other financial indicators.

How to calculate and interpret the Quick Ratio or primary liquidity ratio?

Quick ratio formula

If the result of the calculation is greater than 1, it means that the company has enough liquidity to cover its short-term obligations. If the value is less than 1, on the other hand, the company may have difficulty paying its short-term debts.

In general, a quick ratio considered healthy ranges between 1.5 and 2. However, the optimal value depends on the company’s industry and its specific financing needs.

These ratios are important in assessing the financial stability of a company and its ability to continue to operate successfully over time. In addition, they are an important analytical tool for investors because they provide information on a company’s ability to generate sufficient cash flow to repay its debts.

What solutions are available to manage and control corporate cash?

Corporate liquidity is, therefore, one of the key aspects in determining success. Today, still many entrepreneurs, underestimate it and manage it inefficiently.

The best way to go, is to keep an eye on the whole enterprise and monitor it continuously. But are there systems in place to do this? Yes, our ContractSuite software, allows you to predict the future of your business and anticipate strategic decisions. The platform focuses on the fundamentals, namely numbers and deadlines, ensuring that you can plan commitments, manage budgets, and control costs and revenues.

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