How to Quickly Increase Your Liquidity Ratio
The liquidity ratio measures the company’s ability to pay off current liabilities with current assets. It is important because it can indicate if the company is in a good financial position to meet its obligations, it also serves as an alarm to warn the owner that its assets are not being used efficiently.
There are two common liquidity ratios used, the current ratio and the quick ratio. The current ratio examines the percentage of current assets a company holds to meet its liabilities. This ratio enables you to understand a company’s ability to cover its short-term liabilities. It’s a measure of cash-on-hand that a company needs to settle expenses and short-term obligations. Your target ratio should be one that indicates you have adequate liquid funds to pay your current obligations.
On the other hand, the quick ratio is a tool that refines the current ratio, measuring the amount of the most liquid asset a company has to cover liabilities. The quick ratio excludes inventory and some other current assets from the calculation and is a more conservative measurement than the current ratio. This ratio should indicate you have liquid funds without selling your inventory.
Interpreting the Liquidity Ratio
A low liquidity ratio means a company is suffering from financial trouble. The higher the ratio the more likely a company can pay off its debts. However, a very high ratio could mean you are being too conservative and your business could suffer from missing opportunities to grow and expand.
It can also determine creditworthiness. The creditors will be looking at your liquidity to decide if they will extend credit to your business because they want to make sure they get paid. That’s why it is important to maintain a healthy ratio so you can get a loan with better terms. Better credit terms improve liquidity, and improved liquidity gets better credit terms You don’t want to break that cycle.
Decrease short-term debt
The most obvious way to swiftly increase your liquidity ratio is by paying off liabilities. You should reduce short-term debt from the balance sheet, meaning, you should opt for long-term financing instead. By using long-term financing, your monthly installments will lessen. And the principal is due at a later date.
Look at Accounts Payable
Negotiate for longer terms from your vendors so you can hold on to your cash longer and see if you can ask for discounts to be applied on your debt.
Mind your accounts receivable
Ensure that your billing is updated and you’re receiving prompt payments from your clients. Revisit your contracts and set up aging accounts to monitor punctual payments. Delays in payments could damage cash flow and liquidity.
Cutting back on short-term overhead expenses such as rent, labor, and marketing will improve liquidity. Look-back on expenses your company no longer needs Leaning your spending will improve not only your liquidity but will also have a good impact on your profits.
Eliminate Unproductive Assets
If you have assets lying around in your company, unused or unproductive, you should start to sell them. After the sale, you will increase cash and stop expensing depreciation. Try and sell them first but if it no longer has value, dispose of them. Either way, you will have lessened your depreciation expense and freed some storage.
Setup “Sweep Accounts”
These are accounts that can automatically transfer funds into a safe but higher interest-earning investment option at the close of each business day when it is not needed and move them back to accessible accounts after.
By using liquidity ratios, the company can strike a balance between being able to pay its obligations and prevent improper capital allocation.
Implement these tips to create a better cash flow and improve liquidity to ensure maintain business operations and provide for the opportunity of company expansion.