What is liquidity?
Liquidity indicates to what extent a company can meet its payment obligations. A company is therefore liquid when it is able to meet all current payment obligations. If this fails, a company is illiquid.
How do you calculate liquidity?
The current ratio is often used to measure liquidity. The current ratio is a key figure that shows the extent to which an organization can meet its short-term obligations (< 1 year).
Current ratio formula: (current assets + liquid assets) / short-term debt
What is good liquidity?
If the above formula results in a current ratio of 1.5, then one can speak of good liquidity. With a current ratio of 2 or higher, the company is absolutely safe in terms of liquidity.
Why is good liquidity important?
Good liquidity is especially important for your own company, because then you know whether you can pay your bill in the short term. If that is not the case, you can intervene in time.
In addition, this is important for your suppliers, because they want the certainty that you can pay them in the short term.
It is also important for banks and financial institutions to know how you stand financially, for example when you apply for a loan.
It is also important for investors. They look at your liquidity to predict whether your company can pay a dividend.
How can you improve your liquidity?
Do you want to improve your liquidity? Then there are a number of ways to do that.
- Pay attention to the payment term. When you shorten the payment term of your outgoing invoices and extend your received invoices (of the bills you have to pay), you keep money in cash for longer.
- Watch your debtor management. To achieve the above, a strict debtor management is important. Because the sooner you send payment reminders and reminders, the faster you get paid.
- Factoring. You can monetize future cash flows (money that your company is entitled to, but has not yet received). You can do this, for example, by selling your debtor portfolio to a factoring company.