Managing liquidity is important for the growth and stability of your company.
That's why exploring different strategies, such as maintaining optimal cash reserves and utilizing credit facilities, can help sustain a business's financial health.
In this article, we'll explore what is liquidity planning, its importance, the steps to create a plan, and challenges that may arise during the process.
Let's begin!
What Is Liquidity Planning?
Liquidity planning involves guaranteeing that your business will have sufficient funds available to cover forthcoming expenses, ensuring that you'll have adequate funds in your accounts to meet your financial obligations.
Regular liquidity planning is essential to avoid being caught off guard by sudden bills or penalties, safeguarding the stability of your SME against unforeseen events.
Pro Tip
Regularly using Puls to manage your income and expenses can potentially increase your credit limit over time.
Furthermore, Puls ensures you use reliable data for business decisions, reducing the risk of formula mistakes, human error, and outdated spreadsheets by providing accurate information directly from your bank account.
Here is how our cashflow planner works:
- The dashboard is structured like a calendar for input and output details.
- Scheduled transactions can be postponed and pushed to the calendar to see possible impacts.
- Assign categories to each payment, with regular payments remembered and transferred monthly.
- Scheduled payments can be saved as a draft and converted to active payment when the time comes to pay.
What Does Liquidity Mean in Financial Planning?
Liquidity is all about how quickly a business can cover its short-term expenses without having to borrow.
It includes things that can be easily converted into funds, like stocks and bonds.
Businesses need to plan for various expenses, such as everyday costs, emergency savings, and money for future investments.
The Goal of Liquidity Planning
Liquid planning ensures you have enough easily accessible cash or liquid assets to cover your short-term expenses.
By ensuring adequate cash reserves, you can avoid selling illiquid assets or taking out loans at unfavorable rates and prevent forced asset sales during market downturns.
Why Do You Need Liquidity Planning?
There are many good reasons to engage in liquidity planning as part of your financial management strategy. Here are some of the key benefits:
- Meet Short-Term Expenses: Anticipate your short-term expenses and ensure you have enough cash to cover the costs without additional loans or selling investments.
- Plan for Unexpected Emergencies: Maintaining an easily accessible cash reserve can help your business handle unexpected expenses or emergencies.
- Minimize Risk During Market Volatility: During market volatility, avoid being forced to sell assets at low prices to cover emergencies or meet other needs.
- Plan for The Future: A long-term liquidity plan can help your business achieve financial goals such as reducing debt, saving for significant investments, or maintaining a stable cash flow for sustainable growth.
Liquidity Planning Pros & Cons
Let’s go through liquidity planning's pros & cons.
Liquidity Plan Key Features
Here are the key features of a liquidity plan:
- Flexibility and Configurability: Liquidity plans should be flexible and customizable, allowing your business to tailor the plan to its specific needs and goals.
- Formula-based Construction: Use formula-based construction to help automate the process and ensure accuracy.
- Multiple Parallel Forecasts: Support multiple parallel forecasts to help you compare and analyze different scenarios.
- Submission and Review Workflow: Include a process for submitting and reviewing forecasts, ensuring the plan is accurate and up-to-date.
- Variance Analysis: Including variance analysis in your liquidity planning can help your business understand the difference between expected and actual cash flows.
How to Calculate Your Liquidity?
Three ratios are commonly used to assess liquidity:
- Current ratio: This straightforward calculation offers a broad overview of your assets in relation to liabilities.
- Quick ratio: A more conservative approach, considering only assets that can be quickly converted into funds within 90 days.
- Cash ratio: The most conservative of the three, focusing solely on existing funds reserves rather than potentially liquid assets.
Choosing the appropriate ratio depends on factors like industry, risk tolerance, and business goals. It's advisable to aim for a ratio between 1.5 and 3, ensuring liquidity without idle capital.
How to Create a Liquidity Plan?
Creating a liquidity plan for SMEs involves several key steps. Let’s go through each separately.
1. Define Your Business Goals
Before starting with liquidity planning, it's crucial to have a clear understanding of your business objectives.
Take the time to identify what your company aims to achieve in the short, medium, and long term.
Whether your focus is on surviving economic downturns, expanding into new markets, or driving innovation, your goals will serve as the guiding principles for your liquidity strategy.
2. Select the Appropriate Ratio
Choose the liquidity ratio that best suits your industry's risk profile and aligns with your business goals.
When deciding between the current ratio, quick ratio, or cash ratio, consider factors like risk tolerance and growth aspirations.
3. Assess Existing Assets and Their Liquidity
Begin by compiling a list of all assets, including tangible assets such as property, equipment, and inventory, as well as intangible assets like intellectual property rights.
Once you have identified your assets, categorize them based on their liquidity.
Cash and cash equivalents are the most liquid assets, followed by marketable securities and accounts receivable.
In contrast, assets such as property and equipment may require more time and effort to convert into cash.
4. Conduct Cash Flow Forecasts
Utilize cash flow forecasting to project your business's cash inflows and outflows over time.
Traditional methods like Excel-based forecasting provide a basic understanding but may lack flexibility and accuracy.
Consider advanced cash flow forecasting software for more comprehensive insights.
5. Ensure Essential Liquidity
Essential liquidity refers to the funds required to sustain day-to-day operations and meet routine financial obligations.
Before allocating resources to other liquidity categories, it's essential to ensure that you have sufficient liquidity to cover essential expenses.
This includes payments for rent, utilities, wages, and suppliers.
6. Exercise Caution in Economic Downturns
During periods of economic uncertainty, prioritize building precautionary liquidity reserves to safeguard against unforeseen emergencies.
While it may be tempting to pursue aggressive expansion initiatives, focusing on strengthening financial reserves can enhance resilience and mitigate risks associated with economic volatility.
7. Seize Opportunities Wisely
Despite the challenges posed by economic downturns, they also present opportunities for businesses willing to take calculated risks.
While maintaining caution, remain vigilant for strategic opportunities that align with your business objectives.
Assess potential risks and rewards carefully, weighing the need for liquidity against growth prospects.
8. Optimize Business Operations
Incorporate insights from cash flow analysis and scenario planning into your business operations to enhance efficiency and resilience.
Identify areas of vulnerability, such as excessive reliance on key customers or suppliers, and develop strategies to mitigate risks.
Liquidity Planning Challenges
While liquidity planning is an important part of financial management, it does come with challenges. Here are some of the key challenges that you need to be aware of when creating liquidity plans:
- Managing Volatility: Market volatility can impact the liquidity and value of your assets, making it more difficult to predict cash flow and adjust your liquidity plan as needed.
- Rising Interest Rates: Higher interest rates can impact the cost of borrowing and make it more challenging to maintain cash flow, particularly if your assets are invested in long-term investments with lower liquidity.
- Inflation: Inflation can diminish the value of your cash holdings over time, particularly if they aren't generating adequate returns.
- Regulatory Compliance: Compliance with regulatory oversight over investment practices can be challenging and require significant resources and expertise.
- Uncertainty in the Global Economy: Global economic conditions can change rapidly and sometimes unpredictably, making it difficult to plan long-term growth or maintain sufficient cash flow to meet short-term needs.
- Technology Influence: Technological advancements and digital disruption can change how we do business and manage liquidity, creating new challenges for which many companies are unprepared.
How to Assess the Impact of Liquidity Planning?
To measure the impact of liquidity planning, you can use several key metrics:
- Cash Conversion Cycle (CCC): Measures how quickly your business can convert investments in inventory and other resources back into cash through sales.
- Weighted Average Cost of Capital (WACC): Evaluate the average rate of return your business needs to earn on its investments to satisfy creditors and shareholders.
- Interest Expense: This represents the cost of borrowing money and can show how debt impacts your cash flow.
- Return on Debt: Indicates how efficiently your business uses borrowed funds to generate profits.
How Can We Assist With Liquidity Planning?
Puls provides small businesses with easy access to financing through innovative financial solutions. We offer loans, financial planners, and multibanking services to help businesses enhance their financial management and support their growth.
General overview:
- The product includes: Cash flow management, which allows users to plan income and expenses while seeing future balance changes.
- Fast and flexible funding: An available line of credit with funds disbursed within 48 hours of loan request for business owners registered in the commercial register.
- Where the money comes from: Loans are issued by Montold SME Lending Fund GmbH & Co. KG, managed by Montold Asset Management GmbH, and brokered by Puls. This fund is registered with BaFin and addresses professional or semi-professional investors.
- Security features: Puls prioritizes data security, using Transport Layer Security (TLS) and Amazon Aurora encrypted database clusters. Customer anonymized data is stored in Germany to meet GDPR standards and the company partners with GDPR-compliant providers like finAPI for account linking.
- Puls App: Download the Puls app (Android and iOS) to receive notifications about your income and upcoming loan installment payments.
What do we offer?
Puls offers various types of services, and those include:
- Connect your business bank account to Puls and receive a credit limit within 48 hours.
- You can tailor your loan to your needs by selecting the amount (up to 100.000€) and loan period (a maximum of 12 months).
- Use our loan calculator for transparent interest calculations.
- Get the highest credit limit by connecting all your business bank accounts.
- No obligation to use the credit limit; it does not impact your creditworthiness.
- Offers tools to plan finances and forecast cash flow.
- Provides insights to track expenses and optimize spending across banks and companies.
- Categorize and label transactions for enhanced financial management.
- Connect all your bank accounts and manage them in one place.
- View balances and manage payments quickly and efficiently.
- Access transaction history and download data in CSV format for accounting purposes.
- Use categories and labels to group financial activities across banks and companies.
How does it work?
This is how our loan service works:
- Apply for a loan and decide on the amount and term.
- Sign the contract and identify yourself.
- Receive the money directly to your bank account.
Join us today and explore further possibilities and how we can assist with your liquidity planning!
