Best Practices for Liquidity Management in Small Businesses

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As
a
small
business
owner,
it’s
important
to
be
able
to
quickly
access
cash
when
you
need
it.
But
having
enough
liquid
assets
on
hand—cash
reserves,
CDs,
and
money
market
accounts—doesn’t
come
automatically.
It
takes
careful
foresight
and
strategic
planning.
Without
sufficient
liquidity,
business
challenges
can
lead
to
operational
disruptions,
and
growth
opportunities
might
be
missed.
This
article
looks
at
best
practices
for
managing
liquidity,
providing
business
owners
with
strategies
to
optimize
cash
reserves,
and
improve
both
cash
inflow
and
outflow.

Key
Takeaways

1. Liquidity
   ratios
   can
   help
   you
   monitor
   your
   company’s
   financial
   health
2. Strategic
   planning
   can
   help
   you
   improve
   your
   liquidity
3. Financial
   tools
   can
   significantly
   improve
   cash
   management.

Understanding
Liquidity
Ratios

Liquidity
ratios
measure
your
company’s
ability
to
cover
short-term
obligations.
The
most
common
ratios
include
Current
Ratio,
Quick
Ratio,
and
Cash
Ratio.

• 
  Current
  Ratio:
  Shows
  whether
  current
  assets
  are
  enough
  to
  pay
  off
  all
  debts
  due
  within
  one
  year.
  The
  formula
  for
  calculating
  current
  ratio
  is:
  current
  assets
  /
  current
  liabilities.
  A
  result
  greater
  than
  1
  is
  a
  sign
  of
  good
  short-term
  financial
  health.
• 
  Quick
  Ratio:
  Also
  known
  as
  the
  acid-test
  ratio,
  this
  lets
  you
  know
  if
  you
  can
  settle
  short-term
  obligations
  without
  selling
  off
  inventory.
  The
  formula
  for
  calculating
  quick
  ratio
  is:
  (current
  assets
  –
  inventories)
  /
  current
  liabilities.
• 
  Cash
  Ratio:
  Assesses
  your
  ability
  to
  pay
  off
  short-term
  debt
  with
  cash
  and
  cash
  equivalents.
  The
  formula
  for
  calculating
  cash
  ratio
  is:
  (cash
  +
  cash
  equivalents)
  /
  current
  liabilities.

Optimizing
Cash
Reserves

As
a
business
owner,
you
should
always
keep
enough
cash
on
hand
to
cover
unexpected
expenses
and
to
take
advantage
of
interesting
opportunities.

To
build
your
cash
reserve,
consider
the
following
strategies:

• 
  Set
  Up
  an
  Emergency
  Fund:
  Put
  a
  portion
  of
  your
  profits
  every
  week
  into
  a
  “do
  not
  touch”
  fund
  that
  you
  only
  use
  in
  the
  case
  of
  an
  emergency.
• 
  Regularly
  Review
  Cash
  Balances:
  Keep
  an
  eye
  on
  how
  much
  cash
  you
  have
  on
  hand
  to
  ensure
  that
  you
  have
  enough
  to
  meet
  all
  your
  business
  needs.

Enhancing
Cash
Inflows

Improving
cash
inflows
is
essential
for
maintaining
liquidity.
Here
are
some
strategies
small
business
owners
should
consider:

• 
  Accelerate
  Accounts
  Receivable:
  If
  you
  haven’t
  already,
  switch
  to
  electronic
  invoicing
  to
  speed
  up
  payment
  collections.
  You
  can
  also
  offer
  incentives
  for
  early
  payments
  or
  set
  clear
  payment
  terms
  to
  encourage
  timely
  payments
  (including
  switching
  from
  net
  30
  to
  net
  15).
• 
  Explore
  Additional
  Revenue
  Streams:
  Look
  for
  opportunities
  to
  upsell
  your
  current
  customers
  and
  consider
  adding
  new
  products
  or
  services
  that
  might
  increase
  your
  flow
  of
  new
  customers.

Managing
Cash
Outflows

Another
way
to
ensure
healthy
liquidity
is
to
control
cash
outflows.
Two
simple
strategies
for
doing
this
include:

• 
  Timing
  of
  Payments:
  Time
  your
  payments
  to
  suppliers
  and
  creditors
  in
  conjunction
  with
  your
  cash
  inflow.
  You
  can
  also
  try
  to
  negotiate
  terms
  that
  extend
  the
  time
  you
  have
  to
  make
  payments,
  allowing
  you
  to
  keep
  your
  cash
  on
  hand
  for
  longer.
• 
  Expense
  Management:
  This
  goes
  without
  saying,
  but
  if
  you
  are
  tight
  on
  cash,
  look
  for
  unnecessary
  expenses
  that
  you
  can
  cut.
  Additionally,
  you
  may
  be
  able
  to
  automate
  some
  tasks,
  saving
  on
  labor
  and
  increasing
  efficiency.
  You
  should
  routinely
  check
  credit
  card
  statements
  and
  invoices
  for
  errors
  and
  for
  subscriptions
  and
  services
  that
  you
  are
  no
  longer
  using.

Utilizing
Financial
Tools
and
Technology

Financial
tools
and
technology
can
be
used
to
streamline
cash
management
processes:

• 
  Cash
  Management
  Software:
  Nobody
  should
  be
  doing
  their
  books
  by
  hand
  anymore.
  Easy
  to
  use
  software
  like
  QuickBooks
  and
  Xero
  make
  bookkeeping
  simple,
  saving
  you
  time
  and
  effort.
• 
  Integration
  of
  Automated
  Systems:
  Make
  sure
  all
  of
  your
  financial
  management
  systems
  are
  linked
  and
  providing
  real
  time
  data
  and
  analytics,
  ideally
  in
  a
  single,
  easy
  to
  use
  dashboard.

Relationship
Management
with
Financial
Institutions

As
you
work
on
improving
liquidity,
don’t
think
that
you
have
to
go
it
alone.
Your
bank
or
financial
institution
has
resources
that
can
help,
ranging
from
education
to
offering
you
better
terms
on
loans
and
access
to
credit.

One
option
to
consider
is
a
business
credit
line.
Credit
lines
are
similar
to
credit
cards,
in
that
you
can
qualify
for
a
predetermined
amount
of
credit,
but
you
never
have
to
use
it,
and
you
only
pay
interest
on
the
amount
that
you
use.

Planning
for
Seasonal
Variations

Cash
flow
can
be
influenced
by
seasonal
business
cycles.
Here’s
how
to
proactively
plan
for
this:

• 
  Adjusting
  Your
  
  Liquidity
  Management
  Strategy:
  Set
  some
  money
  aside
  during
  your
  busy
  season,
  as
  it
  can
  be
  a
  lifesaver
  during
  the
  slow
  season.
  For
  example,
  if
  you
  see
  a
  surge
  in
  sales
  before
  the
  holidays,
  hold
  some
  back
  for
  operations
  in
  January
  and
  February
  when
  things
  slow
  down.
• 
  Forecasting
  and
  Budgeting:
  Creating
  detailed
  budgets
  and
  forecasts
  based
  on
  past
  trends
  and
  future
  plans
  will
  help
  you
  set
  realistic
  targets
  for
  both
  savings
  and
  expenses.
  Being
  proactive
  will
  help
  you
  avoid
  being
  taken
  by
  surprise
  when
  business
  doesn’t
  grow
  as
  expected.

Legal
and
Tax
Considerations

Understanding
the
legal
and
tax
implications
affecting

liquidity
is
crucial
for
running
a
growing
business:

• 
  Tax
  Planning:
  Make
  sure
  you
  are
  tracking
  quarterly
  and
  annual
  taxes
  in
  order
  to
  have
  enough
  cash
  on
  hand
  to
  meet
  your
  obligations.
• 
  Compliance:
  Stay
  compliant
  with
  local,
  state,
  and
  federal
  regulations
  to
  avoid
  fines
  and
  legal
  issues
  that
  can
  drain
  cash
  reserves.

Regular
Review
and
Adjustment

Review
your
liquidity
management
strategies
at
least
semi-annually
to
ensure
that
your
tactics
are
keeping
up
with
your
current
needs:

• 
  Financial
  Reviews:
  Reviewing
  your
  finances
  can
  help
  detect
  errors
  and
  catch
  late
  payments
  or
  other
  factors
  that
  might
  cause
  trouble
  down
  the
  road.
• 
  Audits:
  Make
  use
  of
  regular
  financial
  audits
  to
  identify
  areas
  for
  improvement
  in
  your
  liquidity
  management
  processes.

Conclusion

Small
businesses
need
liquidity
management
to
succeed
and
grow.
By
using
the
ratios
and
best
practices
laid
out
in
this
article,
you
can
keep
your
company
financially
stable
and
ready
for
whatever
comes
your
way.
But
remember,
liquidity
management
isn’t
a
one
time
thing—it’s
an
ongoing
process
that
involves
regular
monitoring
and
review.
And
if
in
the
process,
you
discover
that
you’re
in
need
of
financing,
be
sure
to
check
out
the
solutions
available
from
Biz2Credit.

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