4 tips: improve a company's liquidity

What Does Liquidity Mean?

Liquidity is undoubtedly one of the central pillars for a company's survival and competitiveness. Liquidity refers to the ability to meet all due payment obligations on time. It indicates how quickly available funds can be used to settle short-term debts. In the business world, liquidity plays a crucial role, as it determines whether a company can meet its ongoing obligations and thus remain financially sound.

External factors such as pandemic-related restrictions (e.g. the Covid crisis), market fluctuations, or legislative changes can significantly impair financial flexibility. At the same time, various internal measures are available for companies to actively improve their liquidity and thus strengthen their market position.

Status Quo: Calculating Liquidity

Before you can improve liquidity, it's important that you get an overview of the current situation. There are various metrics that can help provide insight into the liquidity situation.

Calculating Liquidity Ratios

Liquidity ratios, often divided into three levels, provide information on how well a company can cover its short-term obligations with the available liquid funds and quickly liquidisable assets.

First-Degree Liquidity (Cash Liquidity)

This measures a company’s ability to immediately cover its short-term liabilities with available liquid funds (cash, bank balances).

The formula is: (Liquid Assets / Short-Term Liabilities) × 100

A value below 100 per cent indicates that there are not enough liquid funds available to immediately settle short-term debts.

Second-Degree Liquidity (Quick Ratio)

This metric expands cash liquidity to include short-term receivables.

The formula is: ((Liquid Assets + Short-Term Receivables) / (Short-Term Liabilities)) × 100

A value above 100 per cent indicates that the company has enough liquid funds and short-term realisable receivables to cover its short-term liabilities.

Third-Degree Liquidity (Current Ratio)

This metric includes all current assets, including inventory.

The formula is: (Current Assets / Short-Term Liabilities) × 100

A Current Ratio of at least 100 per cent is an indicator that the company can cover its short-term liabilities with all its current assets.

Calculating Liquidity with Cash Flow Analysis

In addition to liquidity ratios, cash flow analysis is another important method for assessing liquidity. It examines the cash flows from operating activities, investments, and financing to understand how money flows in and out of the company. A positive operating cash flow indicates that the company is generating enough income to cover its ongoing expenses.

What Is Good Liquidity?

Good liquidity cannot simply be defined by a specific sum, as the required liquid funds depend heavily on the nature and intensity of a company's economic activities. Companies with high operating expenses will require a higher cash inflow, while lower expenses may be covered by lower income.

The calculations mentioned above provide a rough guideline for assessing whether liquidity is "good". Ideally, a liquidity ratio above 100 per cent for both cash liquidity and the quick ratio shows that a company can not only meet its financial obligations but also handle unforeseen expenses.

When Should Liquidity Be Improved?

Liquidity should be improved if:

• The liquidity ratios of the first or second degree are significantly below 100 per cent, indicating an insufficient ability to cover short-term liabilities.
• Negative operating cash flow exists, meaning that the current business is not generating enough money to cover operating costs.
• There are fluctuations in cash flow that could lead to a liquidity shortfall, especially in economically uncertain times.

Through regular monitoring of these metrics, you can proactively take measures within the company to improve liquidity and ensure long-term financial stability.

Measures and Tips for Improving Liquidity

There are both short-term and long-term measures to improve liquidity. Short-term liquidity means that companies have financial resources available within a very short time (maximum of one year) to cover expenses such as monthly rent, salaries, or insurance.

Long-term liquidity refers to the ability to meet payment obligations through strategic planning over a period of more than five years. For invoices from suppliers or tax payments, longer payment terms are usually involved—this is where long-term liquidity should be improved.

Below, we have compiled four important tips that can help you improve your liquidity to increase your success in the long term.

1. Reduce Your Expenses

One of the most direct and effective measures to improve liquidity is to reduce expenses. A critical look at existing expenditures can often reveal untapped savings potential. There are many approaches here, such as the procurement of materials or services.

Reviewing and possibly renegotiating supplier contracts, for example, can lead to significant cost savings without compromising the quality of your products. Additionally, investing in technology for automation and efficiency enhancement of work processes can reduce medium- to long-term costs. It is important to make savings consciously and strategically to avoid impairing the company's operational performance.

2. Optimise Your Payment Terms

A smart determination and adjustment of payment terms can significantly influence liquidity. It involves setting payment terms so that customers fulfil their obligations in a timely manner, while your company retains sufficient flexibility to manage its own liabilities.

Individually tailored payment conditions with customers can help optimise cash flow and minimise payment defaults. One option is to negotiate payment agreements with customers that are tailored to their specific needs.

3. Use External Financing Options

When all other options for optimising liquidity have been exhausted and you need quick capital, it may be sensible to use external financing options. This can involve taking out a loan from a bank or securing investment from investors.

Bank Loan

A loan from a bank is a quick and straightforward way to raise capital. However, you should bear in mind that banks will take a close look at the financial situation of your company before granting a loan. Good creditworthiness and solid financial planning are therefore essential.

Investment from Investors

Securing investment from investors can also be a good way to raise capital. Here, investors provide the company with funds in the expectation that they will share in its future success. However, you must give up shares in your company, which can have long-term impacts on how the business is managed.

In general: For a process to run as smoothly as possible, time and effort should be invested in preparing data and reports. Excel might not be the best choice here. Those who use dedicated software or tools for liquidity planning can save valuable time.

4. Optimise Your Receivables Management

Another way to improve liquidity is to optimise receivables management. This involves realising the receivables from your customers more quickly and effectively.

For example, you can use reminder procedures to encourage customers to pay overdue invoices. Another option is factoring. Here, the company sells its receivables to a factoring provider, who then assumes the risk of payment default and immediately provides the company with cash. However, there are additional costs associated with this method that need to be considered.

Conclusion: Optimise Liquidity Through Targeted Control

A company’s good credit standing is based on a balanced relationship between current assets and short-term liabilities. By improving liquidity in a targeted manner, it can be stabilised in the long term and the company’s success ensured.

Through targeted liquidity management with a constant overview of your cash flows, you can plan and optimise your processes more effectively, rather than relying on cumbersome Excel sheets. This leads to improved planning security and a sustainable strengthening of financial resilience.

Interested in an individual solution for your liquidity planning? Then book your personal demo now.

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