Liquidity & cash flow – what do they mean and why do they matter?

Liquidity and cash flow are not only essential parts of a business but also the industry terminology. In this article, we will tell you what they mean and why it is important to monitor them.

We can help you with the management of your cash flow and liquidity

Companies often experience fluctuations in their funds for both internal reasons (such as investments and strategic changes) and external reasons (such as economic cycles and the payment difficulties of customers). To prepare for and survive such fluctuations, there are two important terms you should know: liquidity and cash flow. But what do liquidity and cash flow mean and how do you manage them? 

What is liquidity?

In a nutshell, liquidity means the extent to which a company has cash to meet its short-term liabilities. Liquidity also often refers to a company’s ability to convert its assets to cash. A healthy liquidity reserve is one of the most important prerequisites for business growth. In this article, you will find concrete examples of how you can improve your company’s liquidity.

What is cash flow?

As the name suggests, cash flow is the “flow” of cash into and out of a business. Contrary to liquidity, you cannot reliably determine a company’s ability to pay their liabilities based on their cash flow.  

Four tips to improve your liquidity and cash flow

1. Good business routines improve your liquidity

Review your daily business routines, such as invoicing and bill payments. Are you taking advantage of your payment terms? Do you have a good overview?

Keep an eye on your budget and regularly check your actual spending. Have you not taken into account something that is draining your cash reserves? Are there any unnecessary expenses you could cut?

When you have set up good daily business routines, make sure you keep them up.

This will give you a good overview of your payments and actual cash position.

2. Do your invoicing as soon as possible

The faster you send your invoices, the sooner you will be paid. If needed, you can do your invoicing more frequently than once a month. 

3. Talk to your suppliers

Review your supplier agreements. Do you need extended payment terms? 

4. Deploy automated processes 

Spend less time on administration and more on delivering value to your business.

With e-invoicing you can make sure that your invoices and reminders are sent in no time. You will also have a better overview of your payments.

Tips for dealing with seasonal fluctuations

Seasonal fluctuations are usually about much more than just the demand for purely seasonal products, such as Christmas trees and sunglasses. Most sectors are exposed to seasonal fluctuations, the cycle and impact of which depend on the sector. 

Some businesses may experience strong monthly fluctuations, but most are affected by changes in season; the time of year or the peaks and troughs in the business. You may not have even realised that the weather, holiday seasons and other peak periods often have either a direct or an indirect impact on your business. These fluctuations may affect your business greatly – especially if you are not prepared for them. Are you aware of the seasonal fluctuations affecting your business? And if you are, have you prepared for them?

Get a clear overview of your budget

  • If you are yet to make a budget, we recommend making one as soon as possible.
  • Your budget must be as realistic as possible. If you are expecting to gain a certain percentage of your annual profit over specific months, do not divide your annual turnover by 12 to get a monthly average. 
  • Allocate your profits to the months in which you expect them to be generated to predict the impact of seasonal fluctuations as accurately as possible.

Monitor your liquidity

  • Find out the seasonal fluctuations affecting your business and their impact.
  • If your profits do not cover your expenses (such as bills, salaries and rent), find out how large the difference is in euros. Does the amount exceed the funds available during a slower season?
  • If the seasonal difference in your liquidity and cash flow is large, you can try to adjust your capacity according to seasonal demand by reducing production in the summer months, for example. 

Maintain good supplier relationships

  • Try to negotiate extended payment terms or hire purchase for larger amounts.
  • Remember that you are the customer – building and maintaining good relationships with your suppliers may in some cases help you to get flexibility on your payment terms if you find yourself in a difficult situation. 
  • It is important to remember that you must always discuss any exceptional arrangements related to payments with your suppliers in advance.

Use bank loans or credit as a financial buffer if needed

  • Seasonal fluctuations are a natural part of business, as is the occasional need for additional financing resulting from them.
  • A corporate credit card gives you additional liquidity when you need it.
  • A credit account also provides you with additional liquidity in times when your profits vary.
  • If you need a larger amount of money, we recommend applying for a corporate loan, which works as a strong financial buffer.

Are your customers not paying their bills on time?

Are you dealing with late payments and having to send several reminders to your customers? Late payments cause liquidity challenges, but mostly for short periods of time only. Constant late payments restrict your business opportunities and operations and make your finances more vulnerable. Luckily, there is a lot that can be done to improve such a situation.

Have a dialogue with your customers

If you have built good customer relationships, you can negotiate payment terms with your customers.

For example, your due dates may not work well for your customer, in which case opening a dialogue may lead to a solution will be better for both parties.

Use automatic invoicing and track the amounts and due dates 

When using automatic invoicing, you can be sure that invoices and reminders are duly sent. You will also get notifications of unpaid invoices. An unpaid invoice can be a sign of financial hardship on the customer’s part, but it may as well be attributed to human error or forgetfulness.

Factoring is a form of finance which offers you protection against unpaid invoices. In a factoring arrangement, your company is provided with financing against your accounts receivable. 

Draw up your credit policy

Does your company have a written credit policy? Draw up a clear framework and set of rules for the payment terms for new customers. Having a written credit policy helps you resolve any future disputes that may arise.

Offer a discount to customers who pay on time

Be proactive and reward customers who pay on time.

A reward can be, for instance, a cash discount or a more symbolic gift.

Charge default interest on late payments

A monthly default interest rate of 1–2% is commonly added to late payments. Settle on a default interest rate that fits your sector, business and customer group. Between companies, interest on late payments can be agreed (or determined on the invoice), but with the consumers, the interest for late payment must be in line with the interest rate law.

Do you have international customers?

If you have international customers, you can use documentary credit, import collection or bank guarantees. These arrangements enable customers to pay in advance and you will get the money once the buyer has received the goods. This way both the buyer and the vendor avoid risks.

Your bank can offer you various finance solutions

Liquidity is crucial when it comes to your business operations. If your incoming payments do not cover your outgoing payments, your business will run into trouble sooner or later.

A credit account gives you additional liquidity in times when your cash flow is weak.

Are you already familiar with factoring? It is a flexible form of finance, which helps your business to cash in your accounts receivable despite the payment difficulties of your customers. Factoring effectively converts your credit sales to cash sales. Please note that factoring is usually best suited to companies with a turnover of at least 1 million euros due to high administrative costs. 

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