Capital liquidity is essential for every business. It’s the business’s lifeblood. Without enough, you could face challenges in meeting your financial obligations and ultimately, your company could go bankrupt.
Improve your capital liquidity
To ensure that you always have enough liquid capital, work to raise sufficient capital at every stage of your company’s growth. At different times, this could include capital from angel investors, venture capital firms, bank loans, and corporate partners, as well as shareholders, should you decide to offer shares to the public. Use standard measures of liquidity, including key ratios that show cash flow or current assets against liabilities. You can also improve liquidity by not letting your cash sit idly. For example, you could earn overnight interest on a sweep account.
Consistently raise capital
When starting your business, you might have managed with a modest amount of cash. Perhaps you used your own savings plus a loan or loans from a relative, friend or angel investor. As your business grows, it typically needs more capital as you invest in product development, a growing management team, or more extensive marketing programs.
Raising capital as your business grows could lead to partnerships with investors, such as venture capital firms, which have greater resources and expertise, and could bring your business to a new level. Benefits could include a broad network of business contacts along with in-house expertise and access to additional capital as needed. Bank loans can fill out the picture once you have established a solid track record and can show that your business is credit worthy.
A general rule of thumb when raising capital to fuel growth: Aim for a cushion of 20 percent. In other words, try to raise 20 percent more than you think you’ll need.
How to measure liquidity
Liquidity is the ability to cover your company’s short-term cash needs. It’s typically measured through ratios, such as the current ratio and quick ratio. In accounting, “current” refers to a debt that must be paid – or an asset that must be used – within a year. If a company has a negative working capital balance (less current assets than liabilities), it will likely need to get outside funding for its short-term operations. That could mean owing interest if you borrow money or perhaps giving up some equity in the business if you receive venture capital or issue shares to the public.
Common liquidity ratios include:
Current Ratio: Current assets / Current liabilities
This measures a company’s ability to pay off its current liabilities (payable within one year) with its current assets, including cash, accounts receivable and inventories.
Quick Ratio: Current assets - Inventories / Current liabilities
This measures a company’s ability to meet its short-term obligations with its most liquid assets. That’s why inventories aren’t included.
Each ratio allows you to look objectively at the current situation and compare it with earlier periods to gauge a company’s financial health.
Keep your working capital working
Start by earning interest on your cash. Transfer funds that you don’t need right now to interest-paying accounts. A sweet account will sweep all unused funds from operating accounts into an account that pays interest.
Another way to improve liquidity is to sell “unproductive assets,” or assets that aren’t generating revenue. This could include obsolete inventory. Having a high amount of accounts receivable could also indicate unproductive assets, and this could hurt your cash flow. Consider providing incentives to clients to encourage them to pay bills on time or early.