In this article we will tell you how to achieve a successful increase in liquidity. For the success of a company, the planning of a permanent assurance of solvency is one of the most important factors and should not be neglected under any circumstances.
Companies that do not meet their payment obligations are at risk of insolvency in the worst case. To help you increase and secure your liquidity, we would like to present the most important measures for improving liquidity in the following article.
Definition: What does liquidity mean?
- Liquidity describes the company's ability to pay on time.
Liquidity refers to the solvency of a business. If a company is liquid, it can meet payment obligations (e.g. salaries, invoices, ancillary costs) within the specified period.
If, on the other hand, liquidity is poor, obligations are usually paid late or not at all, which in return can lead to insolvency and, in the worst case, to the insolvency of the company. A careful Liquidity planning and the Use of financing solutions can prevent bankruptcy.
Accordingly, the company should always have sufficient financial resources at its disposal to cover the Success of the company in the long term.
Different types of liquidity
A distinction is made between two different Types of liquidity:
- Vertical liquidity: The process by which the company converts its own assets into capital in order to meet payment obligations.
- Horizontal liquidity: The available financial resources are related to the burden of capital claims. It is influenced by interest and necessary repayments.
Furthermore, liquidity is also distinguished with regard to the following Determinants:
- Product liquidity: The disposal of existing assets in order to achieve greater solvency.
- Liquidity lent: The lending of assets from credit institutions to improve liquidity.
- Anticipated liquidity: Lending by a credit institution, whereby the credit institution has little collateral and carries out a creditworthiness check.
- Future liquidity: A financial plan is used to determine how future earnings will affect liquidity.
Calculation of liquidity by liquidity ratio
In order to recognise an insolvency in good time and to ensure liquidity, calculations of liquidity on the basis of 3 liquidity ratios are helpful. These ratios belong to the business management ratios and describe the degree of coverage of the company's payment obligations with its liquid financial resources. These ratios can be used to estimate whether a company quickly has enough money to meet its payment obligations.
As already mentioned, a distinction is made between three different liquidity levels.As the level increases, additional components of current assets are used to cover current liabilities:
- First-degree liquidity: Cash liquidity, cash ratio
- Second Degree Liquidity: Collection Liquidity, Quick Ration, Acid Test Ratio
- Third-degree liquidity: Sales-related liquidity, current ratio.
Formula for calculating liquidity:
The liquidity ratios are calculated on the basis of the balance sheet and provide information on the liquidity of the company.
How to calculate the liquidity
1st degree liquidity (cash ratio or cash liquidity)The key figures put the liquid assets (e.g. cash or bank balances) in relation to the short-term liabilities of the next 12 months (e.g. tax provisions). This provides a quick overview of whether payments due in the short term can be settled by the liquid assets. If the liquidity ratio is 100 %, a company can therefore pay all its debts with cash and/or bank balances. However, this is usually rarely the case and the benchmark for 1st degree liquidity is around 20 %. A high level of cash liquidity offers more security, but has a negative impact on the profitability of the company.
2nd degree liquidity (quick ration or acid test ratio (ATR), also collection liquidity): Unlike 1st degree liquidity, securities (e.g. stocks, bonds) and short-term receivables (e.g. trade, rent) are added to cash and cash equivalents, but again these are set in relation to short-term liabilities. The result is 100 % or above.
Liquidity 3rd degree (current ratio): Here, too, another factor is added to the ratio, i.e. the total current assets are offset against the current liabilities.
In some formulas, when calculating 3rd degree liquidity, instead of "current assets", you usually see a split into:
- Cash and cash equivalents + current receivables + inventories
The so-called inventories include raw or auxiliary materials and work in progress and finished goods, depending on the company. In the case of 3rd degree liquidity, the result is above 120 % or higher, whereby a result above 125 indicates that the company can fully cover its short-term liabilities and, in addition to cash and cash equivalents, short-term receivables are also used and inventories are available.
Examples of the calculation of liquidity by grades
The following company balance sheet is available for this purpose:
|Current assets||Borrowed capital|
|accounts receivable trade||900.000||accounts payable trade||1.000.000|
|liquid assets||500.000||Bank loan (< 1 year)||225.000|
|Bank loan (> 1 year)||2.700.000|
Provisions and bank loans with a term of more than 1 year are recognized at the long-term liabilities are counted as liabilities. Trade payables and bank loans with short terms to maturity represent the current liabilities represent
Calculate liquidity of the 1st degree
Liquidity 1st degree=liquid assetsLiabilities+bank loans = 500,0001,000,000+225,000 ⋅100=40.8 %
To calculate 1st degree liquidity, cash and cash equivalents are divided by the sum of trade payables and bank loans. This results in a value for the liquidity 1st degree of 40.8 %.
Calculate liquidity of the 2nd degree
Liquidity 2nd degree=liquid assets+current receivables payables+bank loans = 500,000+900,0001,000,000+225,000 ⋅100=114.3 %
In order to calculate the 2nd degree liquidity, the liquid funds and short-term receivables are divided by the short-term liabilities and the bank loan. This results in a value for the 2nd degree liquidity of 114.3 %.
Calculate liquidity of the 3rd degree
Liquidity 1st degree=Current assetsLiabilities+Bank loans = 500,000+900,000+1,200,000 1,000,000+225,000 ⋅100=212.2 %
To calculate the 3rd degree liquidity, the total current assets are divided by the current liabilities and the bank loan. To determine the current assets, the sum of cash and cash equivalents, trade receivables and inventories is first calculated. In this example, the calculation is as follows: 500,000 + 900,000 + 1,200,000. This results in a value for the 3rd degree liquidity of 212.2 %.
Is the company now liquid?
If all benchmarks are met in the calculations of the different straight lines, the company is considered liquid. The company in our calculation example would therefore be liquid and able to meet its payment obligations.
|1st degree liquidity||approx. 20 %||40,8 %|
|Second degree liquidity||> 100 %||114,3 %|
|Third-degree liquidity||> 200 %||212,2 %|
If you take a closer look at the factors of the individual calculations, you will already get a feeling for where you can implement optimisation measures to increase liquidity. After taking another look at what effects a lack of liquidity or too much liquidity can have, we will look again at securing and increasing liquidity.
Lack of liquidity: Why is liquidity important?
We now know how to calculate the three degrees of liquidity and whether or not cash is missing to meet obligations. But why is this important? If the company does not have sufficient liquidity and cannot meet payment obligations, it falls further and further behind, which leads to poor relations between customers, suppliers and employees. Ultimately, the existence of the company is put at risk; in the worst case, insolvency looms.
In addition to an insufficient equity ratio, a lack of liquidity is the most common cause for filing for insolvency. If a company is unable to pay receivables on time in the short term, this is referred to as a bottleneck, but if this problem persists, it is an insolvency, which in turn means bankruptcy. If the company runs into a liquidity bottleneck, this must be dealt with as quickly as possible. Mostly help here alternative financing solutionsas fulfin offers it.
What happens when liquidity is too high?
But too much liquidity has a negative impact on the growth of the company as well, because it indicates that too much liquid assets remain unused. The higher the liquid assets, the lower the capital commitment and therefore the lower the profitability. If the company decides not to invest the funds wisely in growth, the money will lose value due to inflation. Therefore, the available capital should be invested in such a way that it is conducive to the growth of the firm. If we look at the degrees of liquidity again, we find that a company can have too much capital in the following places:
- high level of cash and cash equivalents: Bank deposits hardly earn any interest and lose value over time due to inflation. The available capital should serve the company's growth and be reinvested profitably.
- high current receivables: Although these show good sales figures, one should also consider historical data on payment defaults in order to check the risk. Only in this way can short-term receivables also become incoming payments.
- high inventories: Stockpiling costs money, so the turnover should be large. If inventories are too high, this can be an indicator of poor sales. What kind of stocks are involved depends on the business. A large number of perishable food items that cannot be sold are certainly not ideal stocks.
Securing: How can liquidity be secured?
Who wants to prevent too low liquid funds, can different short-term and long-term measures seize. Popular approaches are the Reduction of payment terms through a strict dunning system for customers. This means that outstanding receivables can be collected more quickly and guarantee the company faster liquidity.
Furthermore, the Goods and Stock reduced to free up capital for payment obligations. But also Shares or business shares can be sold in order to secure or improve liquidity in the short term.
Whether measures need to be taken and when they need to be taken can be determined primarily with the help of a careful Liquidity planning . This is an important part of the company's financial planning and focuses on all income and expenses.
The aim of liquidity planning is to know at what point in time which liquid funds are and must be available. Only in this way can it be recognised at an early stage on which days a liquidity bottleneck may occur and through which intervention measures these can be prevented.
Measures: How to increase liquidity?
There are many different measures to increase liquidity. These measures can be aimed at a short-term or long-term improvement. In the following section, we would like to take a look at some measures and explain them a little. Some optimization measures focus on individual factors of liquidity planning, while others are more general.
1. reduce purchasing costs
You can work with suppliers and subcontractors better conditions such as prices, volume discounts or cash discounts. If you also opt for factoring, you can agree better conditions with suppliers and pay them more quickly.
2. use factoring
In addition, you can use Factoring , because a Sale of invoices or receivables helps to increase liquidity. This means that your customers have a payment term of 60 days, but you receive the money - for a fee - immediately from the factoring company. Thus, the incoming payments are postponed and free up capital again.
3. leasing as a financing option
Some assets can be leased so that you can invest capital elsewhere. You pay manageable monthly amounts for the vehicle fleet, machinery or business equipment and do not tie up the capital in the assets. Consequently, leasing can also increase liquidity.
4. borrow money
Loans can be used wisely for new investments and growth of the business.
5. reduce goods and storage capacities or tie up liquidity
In some cases, the goods and storage capacities can also be reduced so that less equity is tied up. This is because not all goods in stock are actually needed and only worsen liquidity unnecessarily. However, inventory financing can be used to capitalize the inventory in order to capitalize the liquidity tied up in the inventory. In this type of financing, as also offered by fulfin, the traded goods have already been ordered and paid for; they are therefore in the inventory of the warehouse. The equivalent value of the goods in the warehouse serves as collateral for the financing sought. The amount of the credit granted is based on the total value of the existing stock.
6. use tax advantages
Your tax advisor is usually responsible for this area: Check whether you can make use of tax advantages. This can be the use of tax allowances or the reduction of advance tax payments.
7. insure against non-payment
You can also improve liquidity through payment default protection. For large orders, always check the creditworthiness of the customers and/or have yourself insured against payment defaults through trade credit insurance.
8. examine marketing costs
The expenses for advertising or marketing are of course important, but should not be immeasurable. Therefore, check how sensible the investments are or whether there is a need for optimization here. Here, too, there are effective and less effective measures, so you should have a well thought-out marketing strategy.
9. dunning and receivables management
Invoices should be issued after the goods or services have been delivered and should be provided with a realistic and not too generous payment term. The payment deadline and the payment conditions must be clearly formulated so that a consistent multi-stage dunning process can be operated.
10. retention of earnings
Retaining profits increases liquidity, but retained earnings can also be viewed negatively, as they can also be a sign that there are not enough investment opportunities available for growth. Therefore, profits should not be retained indefinitely, but only to ensure stable growth of the company.
Further short-term and long-term measures to increase liquidity by division
|Short-term solution||Long-term solution|
|Liquidity management||Set output prioritiesControl incoming payments if necessary Output stop||Create liquidity plan|
|Fixed assets||Sale-and-lease-back Check whether certain activities can be outsourcedCheck planned investments lease necessary investments do not buy them||sell fixed assets not required for operations (land, machinery,|
vehicles etc.)rent out rooms that are not neededrent out machines that are not being used to full capacityrent out vehicles
|Inventories||Special sales promotions (e.g. slow-moving items, special offers)||Obtain goods on consignmentCheck and optimize orderingSet production to stockShift stock to customers|
|Receivables||FactoringInvoices on account for partially completed deliveries and servicesPromote advantageous means of payment (cash, direct debit, discount bills)Immediately send reminders for overdue accounts receivable||Agree customer down payments and progress paymentsInvoice completed orders immediately (invoice with delivery)Shorten payment terms for customersCreate payment incentives (e.g. customer accounts)Check dunning processIf reminder is unsuccessful: legal dunning procedureExternal debt collection (collection agency)Monitor and document customer payment behaviourAvoid customer payment defaults by checking creditworthinessSales financing via bank|
|Equity||Private deposits Temporarily suspend savings contributionsTemporarily suspend or possibly terminate life insurance policiesReview donations, membership fees, etc. and reduce or suspend if necessaryReduce contributions to compulsory workmen's compensation insurance if necessaryReduce private withdrawals to a minimumClaim outstanding deposits||Check contributions to pension schemeCheck health insurance for savings opportunitiesAcceptance of new shareholders (e.g. silent partnership, equity investment company)|
|long-term loans||When financing necessary new investments, agree redemption-free yearsDeferment of repaymentSufficiency loanAgreement on a suspension of repayment for loansRescheduling of excessive short-term liabilities||Review of interest rates|
|current liabilities||Increase working capital credit (e.g. overdraft facility)Utilise payment periods for invoices (e.g. from suppliers) as far as possibleSelect advantageous payment method (e.g. cheque/bill of exchange procedure, bill of exchange, cheque)Pay urgent obligations in instalmentsMake concrete agreements with main creditors (e.g. payment by instalments)Regulate relationship with small creditors Agree settlement with creditors|
|Expenses||Explore reduction of personnel costs Review voluntary benefits and special payments to employees Reduce overtime Reduction of advance tax payments Defer tax payments Critical review of all expenses|
|Proceeds||Complete orders that have been started as quickly as possibleComplete residual work and complaints for individual orders as quickly as possible||Marketing measures|
Liquidity is the ability of a company to meet payment obligations on time and is an important prerequisite for ensuring the long-term success of a company.
Planning, securing and increasing liquidity are important tasks for the company. There are 3 different liquidity levels for calculating liquidity. To avoid liquidity bottlenecks, they should carry out careful liquidity planning and make timely decisions about Financing options and also make use of them. Sufficient capital should always be available for unscheduled payments, because a lack of liquidity leads to insolvency and, in the worst case, insolvency. Too much liquidity, on the other hand, lowers the profitability of the company.
FAQ - Increasing liquidity
What does liquidity say?
Liquidity is the indicator of whether a company is able to meet payment obligations on time. Accordingly, a liquid company is solvent and can settle outstanding receivables, pay salaries to employees, cover incidental expenses and reinvest capital.
How can I increase liquidity?
The liquidity of a company can be maintained by various measures such as the release of capital (Factoring), profit retention and/or capital increase. However, liquidity can also be improved in the short and long term through other approaches: Reduce purchasing costs, reduce capacities or alternatively use commodity and inventory financing to bridge bottlenecks.
Why is liquidity important for a company?
In order to ensure the company's success in the long term, the solvency or liquidity of the company is an important key figure. A company that is in good financial condition can also exist in the near future. With the help of careful liquidity planning, the company's financial situation can be determined and future payment difficulties can be identified in good time.
What influences liquidity?
Payment demands vary and can affect liquidity; major investments and business expansions also have a long-term impact on liquidity.
What happens when liquidity is too high?
However, if a company has too much cash on hand, this has an impact on profitability. The higher the liquid assets, the lower the capital commitment and thus the profitability. If the money is not invested wisely, it loses its value through inflation. Consequently, the available capital should always be used for business growth.