Liquidity

What liquidity means

Liquidity means the ability to meet payments when due. It is independent of profit: a business can report high profits and still fail to pay an invoice, because the money sits in stock or in open receivables. Conversely a business with a loss can stay solvent as long as enough money flows in.

Three degrees are distinguished. Short term liquidity looks at whether the funds suffice for the coming weeks. Medium term looks at months and includes receivables and stock. Structural liquidity asks whether the business model generates money at all or consumes it permanently.

Which figures help

• Cash balance: what is available in the accounts, without credit lines.
• Open receivables: what is invoiced and unpaid, with an ageing structure. Amounts open beyond 60 days belong viewed separately.
• Liabilities: what is due in the coming weeks, including wages, taxes and suppliers.
• Cash conversion cycle: how many days lie between paying for goods and receiving money. The most important figure for a shop.
• Reserve: how many months could be bridged without revenue.

Why growing shops get into trouble

Growth consumes money before it produces money. Anyone selling more buys more goods, pays more staff and advances more advertising. The income arrives only after delivery and payment terms. The result grows, the account empties. That effect explains a large part of the cases in which a business with good figures becomes insolvent.

The structure of retail makes it worse. Goods are paid for immediately or within a short period, while customers have 14 to 30 days and invoice buyers even longer. That gap has to be bridged from own funds or a loan, and the faster the growth the wider it gets.

How liquidity is planned

The most effective tool is a rolling plan over a short period, twelve weeks being common. It shows for every week which inflows and outflows to expect and makes bottlenecks visible before they arrive. The advantage over an annual plan lies in accuracy: weeks can be estimated solidly, quarters cannot.

Four levers keep the situation stable. First align payment terms: anyone granting customers long terms should negotiate short ones with suppliers. Second lower stock, because slow moving goods are money tied up. Third set up credit lines before they are needed, because a bank decides differently in trouble than in quiet times. Fourth stagger investments and avoid the strongest revenue period.

How large the reserve should be

Two to three months of expenses is common for a shop with a stable business. With strong growth or a seasonal pattern rather more, because the swings are larger. The reserve belongs in a separate account, otherwise it gets used in daily business. It is not profit and not a return but the precondition to be able to take decisions in a difficult phase rather than having to.

Frequent questions

• Is the account balance the same as liquidity? No, open invoices belong to it.
• What is the first step? A weekly plan for the coming twelve weeks.
• Does an overdraft help? Short term yes, as a permanent solution it is expensive.