Liquidity issues

When liquidity problems occur in a company, whether temporary or long-lasting, all the attentions and efforts of the entrepreneur and shareholders are usually directed toward finding new liquidity: this might be a logical behavior, except that lack of liquidity is never the cause of a moment of business difficulty. It is, if anything, an effect of it.

That is why it is essential, even for small and medium-sized businesses, to monitor, continuously and carefully, the cash flows in order to have an up-to-date view of the movements of cash in and out of the business.

Cash flows (which are generally measured on a monthly, quarterly, or annual basis) are the main indicators of liquidity and, therefore, of the status of a company’s economic health, and are more crucial than turnover and profit figures for business continuity.

With effective and timely management control, the company will not be caught unprepared and will be able to anticipate and eventually manage liquidity crises appropriately.

Enhancement

WORKING CAPITAL
In order to assess the company’s liquidity and ensure the company’s operation in the short term, one must necessarily value the so-called working capital.

Working capital is nothing more than the amount of resources that make up and finance the operating activities of a business: in practice, it is the money that is used to keep the business up and running on a day-to-day basis. Working capital is basically an indicator needed to check the financial and liquidity balance of the company in the short term.

Operating capital is calculated as the difference between short-term assets (cash, inventories, accounts receivable) and short-term liabilities (accounts payable, accounts payable to employees, current accounts payable to tax authorities).

Solutions

Of course, if operating capital is negative, it means that a liquidity problem is detectable: in practice, the company cannot meet its current liabilities with its receipts (consider, for example, that we have to pay suppliers at 30 days, while we collect at 60 or 90 days).

Let’s say that this situation, that is, a temporary lack of liquidity, can be found in most operating companies: the important thing, as mentioned, is to prevent and manage the situation so that it does not become pathological.

Let us see then, in the case of negative working capital, how corporate liquidity can be improved and on what factors to intervene, imagining the first 5 actions we can take to solve liquidity problems: pay attention to a prudent debt collection policy, consider being able to access a short-term line of credit for timely interventions, if this is not enough switch to long-term forms of financing as a more structural means to deal with more expensive investments, prudent inventory management so that there is an effective balance between the service to be offered and the waste to be avoided, and finally, expert care of early or late payment depending on convenience.

THE 5 WAYS TO PREVENT AND SOLVE LACK OF LIQUIDITY

1. TIME FOR DEBT COLLECTION

Techniques to reduce and anticipate collection time, and thus improve the active component of operating capital, may be different, but all should tend to favor a reasonable collection time or, even better, ensure its continuity over time.

Keep in mind that the sale is nothing more than a loan until the customers pay!
So it will be advisable to reduce invoicing time: if the company is accustomed to invoicing at the end of the month, it might consider, instead, an invoice issuance at the end of each decade of the month or as soon as the good or service is sold (immediate invoicing): in general, the sooner you invoice the sooner you collect.

In the case of large orders or new customers, on which the company has no possibility of prior verification, split payments may be proposed in progressive invoices, asking, for example, for an initial down payment followed by other tranches of payment at certain time limits.

Another technique to anticipate income, and thus improve liquidity, may be to offer a discount, even small, to customers who pay early (e.g., 2% discount payment 10 days invoice date).

2. SHORT-TERM FINANCING

A form of short-term financing, such as a line of credit, can allow the company the supportive liquidity needed to overcome a momentary gap between the payments it needs to make (short-term liabilities) and those it needs to collect (short-term assets).

An overdraft is generally the most commonly used formula, but if the use of these arrangements becomes systematic, the problem is more entrenched and must be addressed by acting on the other factors involved.

3. LONG TERM FINANCING

Sometimes the company needs to make particularly large investments in terms of cost, such as the purchase of new machinery, new premises, or real estate: in these cases, long-term financing may be necessary, which has the advantage of not affecting operating capital.

This type of financing allows the company to defer huge expenses in smaller installments depending on the terms of the loan. In these cases, the interest burden and expenses will have to be carefully evaluated, but the company’s working capital can be preserved.

4. WAREHOUSE MANAGEMENT

Managing the warehouse is difficult, especially in small and medium-sized businesses. It requires a really delicate balance Excessively tight warehouse can negatively affect operations and create delays in orders. Too high stock level, on the other hand, causes idle and obsolescence problems.

Having excess inventories is expensive and, therefore, can actually create liquidity problems. In fact, “making” inventory has a cost (match advisors always repeat to entrepreneurs to see in the warehouse not the stored products but the stacks of bills!) and can cause an imbalance in operating capital, even prolonged over time.

Companies can solve this problem by managing their inventory levels more carefully, making sure they have enough material to serve customers, but not much more.

There are many techniques for optimizing the warehouse, but in general, one should strive to make it as efficient as possible, in order to achieve the ability to meet each sales request quickly, without having excessive quantities of products.

5. POSTPONEMENT/ANTICIPATION OF PAYMENTS (IF IT IS POSSIBLE)

It may be useful to review the payment terms charged by our suppliers to align them as closely as possible with the company’s collection times.

Under conditions of good corporate liquidity, it may be preferable to pay suppliers in advance, against agreed discounts, given the current interest rates charged by banks on current accounts.

Examination of cash flows will, in any case, be necessary to anticipate the impact that the different payment method may have on operating capital, i.e., it will be necessary to understand whether, by anticipating payment, I will be able to maintain the liquidity needed for ordinary payments (salaries, rent, raw materials, current payables, current taxes).

In this case, the company should ask itself the following questions:

• In the case where available cash cannot cover the prepayment, but projected cash flows allow the firm to maintain positive working capital, if the firm chooses to pay in advance through a bank overdraft, what is the cost of the overdraft compared with the advantage gained from supplier discounting?
• In the case of choosing to make an installment or deferred payment to the supplier, does maintaining current liquidity bring the firm a greater economic and flow advantage than an upfront payment?