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Liquidity Problems for Small Businesses – Indications and How to Overcome Them

Cash is the most liquid asset that represents a business’s ability to discharge its financial obligations on time. Making payments to suppliers, incurring revenue expenditure, paying off the employees, investing in new assets from plant, machinery and office equipment to buying inventory for the company; everything demands availability of liquid capital. Management of cash flows is thus one of the major challenges faced by small and large businesses today. Even a business enterprise that is making huge profits may collapse due to non-availability of liquid funds.
So how exactly this gap between earnings and liquidity is created? Because of the timing difference between the two. Therefore a business cannot succeed just by exploring new markets, making new customers, and generating revenues; it should also establish controls over the collection of receivables and payments to suppliers. If a business always makes timely payments to its suppliers but is unable to collect money from its customers, soon it will be out of its cash reserves. Consequently the only options left would be to either sell the current assets or borrow money for discharging obligations falling due. This indicates a serious liquidity and solvency problem.
Indications of Short Term Liquidity Issues
1. Deteriorating Current Ratio – Current ratio is the most common measure of a business’s working capital effectiveness. It is calculated by dividing current assets with current liabilities. It should always be greater than 1. Anything below 1 means that the company does not have enough liquid assets to pay off its short term financial obligation indicating serious liquidity and solvency issues.
2. Late Payment of Expenses – Expenses such as utility bills and financial charges are most common for a small business. Being late on payments would result in late payment surcharge, thereby increasing financial burden. If the company is unable to make timely payment of expenses or has defaulted on a loan payment. There certainly are liquidity issues.
3. Negative Cash and Cash Equivalents – Statement of Cash Flows is an integral part of a business entity’s financial statements because it gives indications about the liquid capital at the disposal of the entity. So even small business should keep an eye on cash flow statement. If the cash account is decreasing gradually or is negative, it indicates a problem.
Overcoming Liquidity Issues
Following remedial measures can be helpful.
1. Preparing periodical cash forecast reports, identifying the problems and addressing them
2. Investing in assets whose returns will match with the discharging period of the obligations
3. Keeping an eye on the current ratio and making comparisons monthly and with other business in the similar industry
4. Establishing policies relating to commitments to keep an eye on credit control. For example, credit should be allowed only if the customer agrees to pay within the next 15 days.
5. Keeping tabs on the business cycle, cash receipts and disbursements
CFO consulting can find to source of your problems and recommend corrective actions