Keeping Cash in Business with Proper Liquidity Management

Objective: To identify the importance of liquidity management from a business perspective, specifically for those businesses with a family-owned and privately-held ownership structure.

Chances are, the majority of the businesses that you purchase goods and services from, as well as many of the restaurants that you frequent on a regular basis, are small to medium sized. With over 64% of the Gross Domestic Product (GDP) currently generated from family-owned businesses in the United States, there’s also a high probability that the business you’re purchasing your goods or services from is a family-owned or privately-held business^¹. The bulk of these business owners and leaders would agree that liquidity, or access to readily available cash, in order to fund short-term investments, cover debts, and pay for goods and services, is critical to the long-term success of their business. In fact, it’s consistently cited as one of the top concerns for business owners^².

Liquidity represents a company's financial performance and their ability to convert assets into cash and revenue. Brett Tijanich, Commercial Team Leader and Senior Vice President at First Bank, said, “Liquidity is so important because without the proper management of your assets, or cash, and liabilities, or debt, your family-owned business is at risk of ending up with potential financial issues that you may not be able to resolve.” Conversely, with proper liquidity management, a privately-held company can use the funds or secure the funds needed for strategic acquisitions in their industry.

Prudently Managing Liquidity Means Better Access to Credit

Unfortunately, a large percentage of small to mid-sized businesses have historically failed due to poor liquidity management. Tijanich explained that a company can better manage their liquidity by consistently reviewing financial turns of accounts receivable and inventory, while also prudently making wise investment choices for the business to pursue. “These financial metrics lead to cash generation,” he said, “and the more judicious a company is at this, the quicker cash is generated.”

Liquidity Ratios

Liquidity ratios are used to measure a company’s ability to pay off its debtors. Tijanich said that liquidity ratios are important to a business’ access to credit and lending because it helps tell the story of a strong and steady company, or one that can weather a market downturn or any known or unknown challenges, in a particular industry. Liquidity ratios are something that should be reviewed quarterly, especially as a company is still in growth mode.

“Respected lenders, such as First Bank, place a high value on liquidity management from prospective clients. We do this by measuring both the current ratio and the quick ratio.

This is pretty consistent from bank to bank and, depending on the industry, this may be slightly different in each case,” Tijanich commented. “However, this is an important tool used to test the health of the underlying company used to repay the debt obligations.”

If a company’s liquidity ratio is high, the owner and other decision makers could consider expanding the business through strategic acquisitions or investments in the company, such as new equipment or new markets. Tijanich said, “You do not want to be too aggressive, nor too conservative. You also don’t want idle cash to just “sit there” because it’s not being used efficiently. On the flip side, this could be an early warning sign of something major on the horizon, if the liquidity ratios are too low.”

Read Navigating a Business Loan: Know the Five C’s of Credit

If you’re a business owner and have questions regarding liquidity management and the requirements for the credit facilities you’ll need for your growing business, please contact your trusted advisors at First Bank. “Consider us a strategic partner,” said Tijanich. “We’re completely vested in the long-term growth of your business. In short, we’re here to help.”