Every business needs to invest enough time and energy in ensuring disruption free cash flow, both short term cash flow and long term funding. The liquidity of a business may change in line with market conditions and also as and when the business itself undergoes change (for example, with expansion plans).
A liquidity crunch impacts the business adversely on many fronts which is why effective liquidity management is a keystone of business success.
1) Streamline Cash Collection Systems
One of the most effective ways to ensure availability of cash within the business is to streamline cash collection systems. In many business (especially SMEs), there is immense scope to dramatically reduce the time taken to collect cash that is owed to the organisation.
The cash may be due from customers or business associates. There are several areas where delays may occur including mail float, bank float and processing float. For a business that runs on a relatively limited working capital, these delays could necessitate a foray for new funds, i.e.: loans, which, in the long run, add further pressure on the available cash. Decreasing the length of float periods is a very effective way to improve and maintain liquidity levels within the business.
2) Centralise Cash Accumulation
Accumulating in one location, the cash received from various sources, is another way to manage liquidity optimally. The advantage with this approach is that the business has a larger sum to invest which means that the range of investments available is expanded. This centralised cash accumulation also gives the business owner far greater control over his most liquid asset. In case the cash is required at short notice, the business owner has immediate access to it.
3) Under Your Business’ Optimal Cash Balance
Understanding the business’s optimal cash balance is one of the essential aspects of effective liquidity management. The business may measure liquidity using Cash to Total Assets ratio, Quick ratio, Current ratio and Net Liquid Balance. However, it is also critical to determine the correct balance between liquidity and profitability. An excessively cautious approach reduces the amount of cash that is available for investment while a liquidity shortfall can result in loss as well. Determining the perfect balance is key to effective liquidity management.
4) Optimise Working Capital
Optimising working capital is yet another way to ensure that the business has adequate liquidity at all times. Other than identifying the ideal liquidity- profitability balance, the business owner should also inculcate a tradition of cash consciousness throughout the organisation. In particular, this mindset should be brought about during the training of staff who will deal with cash disbursements or collection.
5) External Funding
External funding is an inevitable aspect of business operations. However, it is possible to keep funding costs to the minimum to ensure that the least pressure comes to bear on the business’s liquidity position through interest and other funding costs. It is important to research various forms of funding available to identify the least cost option when financing becomes necessary. The business should weight the cost of pros and cons of funding versus equity when it requires additional cash to maintain business operations.
For more tips and techniques on liquidity management, take a look at our Treasury Management Courses