In the context of a business, liquidity can be defined as the ability of the firm to turn its assets like investments, receivables and inventory into cash. It is difficult to sell low liquidity assets for their true value especially at a time when you confront an inventory shortage just before holidays. Here are the top reasons why liquidity is very important for any business.
Need for financing and credit
If you want to borrow money, liquidity is very important for your business. The liquidity ratio of a small business will tell the potential investors and creditors that your company stable and strong and also has enough assets to combat any tough times.
Credit and financing help small businesses pay off the creditors, purchase inventory, and to maintain the payroll during off-season. While a number of small business owners might feel taking loans is a risky thing, there are ways to make sure that you are able to payback your loans comfortably. You just need to do some research and take out only as much loan as you will need.
You will need guidance in deciding smartly
When you are able to monitor your company’s liquidity ratio regularly, you will be in a better position to make sound and well-informed decisions that can contribute to your firm’s profits and growth. If your company has too much liquidity, you can think of expanding your business. However, do not give in to the temptation to spend on what is not part of your business’s strategic planning. The bottom line here is to avoid letting the cash stay idle where it is not used efficiently.
A low liquidity ratio might give an indication that your company has financial struggles and your business is under economic stress. Low ratios can help in anticipating the troubles ahead of your business. Under such circumstances, you can move in to liquidate some assets before it is too late.
More than looking at your business’s current ratios, it is also important to look at your competitor’s ratios. This will help you set your vision ahead and identify the potential opportunities in front of your business.
Liquidity will help you in times of emergency
At this juncture, it is important to learn from what the managing director of Kennon-Green & Co., Joshua Kennon, says, “Remember one important lesson: At least some portion of your net worth should be kept in liquid assets. That liquid portion has one primary job, and that job is to be there when you reach for it.”
In order to increase the liquidity of your business, you must be able to know what your business has that will sell quickly when you fall short of cash. Liquidated stocks, collected receivables, sold inventories, and returned supplied that are unused are all sure ways to boost up cash. It is good to have a plan before adversity knocks your doors.
It is important to monitor your company’s liquidity closely to be able to make informed decisions about your company’s spending. Understand your ratios and also look for different kinds of prospects that will help you generate cash. Go for financing only when needed. Planning carefully will ensure that your company marches towards growth and profits.