What is liquidity and why is it important?
Liquidity is a common term used when discussing how healthy your business finances are. But what is liquidity, why is it so important for your business, and how will your cash flow affect it?
What does liquidity mean?
Liquidity is how much you could pay off your current debts (liabilities) with your current assets. These liabilities could be rent, bank loans, utility bills, or similar debts.
Liquidity usually refers to the liabilities and assets over a short term, year long period. To have healthy liquidity, you should be able to easily pay off your liabilities with your current assets.
Cash is the most liquid asset as this could be used to pay off debts quickly. Similarly, stocks and bonds could be converted to cash fast. But, other assets such as machinery would take longer to convert to their market value in cash. Some assets may not be worth their full value in cash after time, so it’s worth taking this into account before you invest in them.
Why does liquidity matter?
Having a good liquidity in your business can help you have good credit, so you can get business loans. It will also allow you to plan for the future of your business, invest strategically and make informed financial decisions.
On the other hand, if you have bad liquidity then you could struggle to pay your bills and meet the financial demands of your business.
How does cash flow affect liquidity?
Keeping an eye on your cash flow will help you measure the liquidity of your business. Cash flow is the money moving in and out of a business, so knowing how healthy your cash flow is will help you keep your liquidity positive, as cash is your most liquid asset. Here are some tips to manage and improve your cash flow, which will help your liquidity too.
Use accounting software to manage your finances
Accounting software is a great way to keep an eye on your finances, and have an overview of how your business is performing.
Bokio is a free accounting software that lets you do your bookkeeping, invoicing and expenses all in one place. Our automated reports help you to understand your finances so you can make the best decisions for your business.