Solvency – in other words creditworthiness – essentially means that your company is always able to pay its bills on time. In order to do so, you require sufficient liquidity – cash and bank deposits. If this is the case, this means you are “in the black” and have sufficient liquidity. In order to properly assess your company’s liquidity, you need to be aware of the different variants. In business studies, liquidity is generally measured in three different ways. We outline the three key indicators for you:
Why is your liquidity so important
What is liquidity actually? And why is your credit standing so significant? The answers and some useful advice can be found in this article.
Liquidity 1: cash and cash equivalents in relation to liabilities
Liquidity 1 compares your cash and cash equivalents with current liabilities. This refers to debts due within a year at the latest – such as invoices from suppliers or service providers. Liquidity 1 tells you how much of your current liabilities you can settle with liquid with cash and cash equivalents.
Liquidity 2: cash and cash equivalents, securities and receivables in relation to liabilities
Liquidity 2 also includes your company’s securities and current receivables in addition to cash and cash equivalents. This is because both can be turned into cash relatively quickly. The ratio between these three components and current liabilities indicates whether your company can pay its bills. If this figure is below one, your liquidity is too low.
Liquidity 3: current assets in relation to liabilities
The ratio of current assets to current liabilities is indicated by liquidity 3. Current assets include liquid capital, securities, current receivables as well as all inventories (raw materials, semi-finished and finished products). Liquidity 3 grades should always be higher than one and ideally at least two.
How to avoid cash flow problems
Securing liquidity is top priority when it comes to ensuring a company’s survival.If no funds are available to settle outstanding liabilities, your company faces the threat of bankruptcy. In the worst-case scenario, you would have to declare yourself insolvent. According to the State Secretariat for Economic Affairs, a shortage of liquidity is the reason for bankruptcy in 9 out of 10 cases. Your credit standing and a high level of liquidity are therefore vitally important.The aim is to ensure early collection of as much money as possible and to make as few late payments as possible.These tips will help you to keep your liquidity under control.
Carry out liquidity planning
This type of plan will help you to estimate your income and expenditure over the next three to twelve months. How much revenue do you expect? What payment obligations must be met? What is the economic climate in your sector like? If carried out carefully, liquidity planning will help you to estimate your future credit standing. It also allows you to identify any bottlenecks at an early stage. However, it is not a universal remedy as unforeseeable events can always crop up. More information on liquidity planning can be found on the The link will open in a new window federal government’s website for SMEs.
Issue invoices correctly and keep dunning processes short
You should aim to ensure you receive payment from your customers as quickly as possible. Make it as easy as possible for them! Make sure invoices are issued on time and do not contain errors. An incorrect billing address will obviously result in delays. The same applies to payment reminders. Keep reminder periods short and don’t put reminders off. A well-organized dunning system (The debt collection process controlled by you), perhaps even automated, will help in this respect.
Keep money in the coffers
Negotiate favourable payment terms with your creditors so that you don’t have to pay immediately. Instalment payments can help in the case of large amounts of receivables. Delay expensive purchases and investments if they are not urgent. Many items can be rented instead of purchased, from office premises to machinery.
Keep your stock levels low
In addition to cash and cash equivalents, inventories to be sold are also part of a company’s liquidity. Inventories are fixed values as they cannot be immediately converted into cash. The aim is to keep stock levels as low as possible.
Take a closer look
Before accepting large orders, checking the potential customer’s credit standing may be worthwhile. This allows you to make sure your customer has sufficient means of payment. It will prevent unpleasant surprises.
As a last resort: look for new solutions
If you are facing imminent insolvency, various options are available. You could raise capital, for example, such as from shareholders. Alternatively, increasing your non-current liabilities with a bank loan is also an option. To ensure you remain solvent, you could also sell assets no longer required or limit your own salary.
By following this simple advice, you can secure your company’s long-term liquidity – and also its credit standing. It is vital to keep an eye on your income and expenditure.