Five Ways To Avoid A Liquidity Crunch

For a business of any size and across industries, positive cash flow is of utmost importance. While liquidity is essential to unlocking profits for a business, it is also needed to pay employees, repay loans, supplier bills and other short-term expenses. Without adequate liquid assets, the business could face trouble within a relatively short span of time. Especially in the real-estate sector where there are several large-scale developments, liquidity is needed to facilitate transactions for these capital-intensive projects. 

In order to avoid reaching a state of a liquidity crunch, here are five precautions and practices businesses should implement: 

Draw-up financial plans keeping both past and future trends in mind

While in the planning stage, every business must ensure they compare their budget with the actuals, thus taking past trends into account to make concrete plans and have a reference point for the future. Especially in real estate, it is advisable to always take a loan for a longer period than the predicted time-frame, as there are no pre-payment penalties on repayment of loans from the project.

Additionally, one should not go into a project thinking that it can be refinanced later. This is a risk not worth taking as future is largely unpredictable, and may hamper business. Instead, it is a good practice to follow a 10:10 rule at the planning stage, where financials should be adjusted to keep a margin for a 10% drop in the sales price and a 10% increase in the cost of the project. If the numbers happen to drop below a 1x cover, the best would be to do away with the project altogether.

Managing budgets and establishing credibility

Each business initiative should start with a well-thought-out budget based on logical and practical assumptions. The budget then acts as an action plan that helps the enterprise chart out an effective path and allocate funds accordingly to achieve the operational and financial goals of the business. Additionally, a budget plan is essential when seeking loans or equity as a well-planned one can instil faith and establish the credibility of a business to investors and banks. Moreover, defining the investment size well allows for a business to build positive cash flows. It is important to outline the product clearly and highlight the benefits for investors.

Importance of analysing the pattern of expenses

Businesses must put great emphasis on analysing their spending visibility in order to effectively manage expenses. This enables greater transparency through the entire spending cycle, while also helping one to avoid last-minute surprises with regards to exceeding the allocated budgets. An effective way to do this is to set limits to categorised expenses. 

Mapping-out expenses, in turn, helps with future savings visibility, allocation of emergency funds and goal-setting as well as better management of debt for the long and short term. This plan should ideally be flexible in nature so that it can be adjusted as per different requirements in the future, thus leaving no room for shortfalls as well as accommodating greater budgets with growth.

Focus on managing and organising overheads

Overhead expenses must be analysed and controlled in order to check for areas where costs can be cut or processes can be improved to save up essential funds. These include the costs of indirect labour and materials, along with expenses such as insurance and taxes. Finding more affordable alternatives can also help to reduce the cost of procuring goods and services without having to limit the numbers. Businesses must also prioritise paying off any liabilities in order to avoid carrying anything forward and adding to expenses with additional penalties and/or interest.

How to effectively maintain High-Quality Liquidity Assets (HQLA)

HQLAs are those assets that have the greatest potential to be converted into cash quickly. It is good for any company to have these reserves as the requirement for funds can arise at any time. In order to accumulate and effectively manage these, businesses should consider switching from short-term debt to long-term debt to have lower current liabilities at a given point of time. Additionally, choosing low volatility assets as well as diversifying assets can further ensure greater predictability and, thus, preparedness as a result of lesser fluctuations and a less-concentrated impact.

The author is a Managing Partner at EverVantage