Nine out of ten bankruptcies are caused by a liquidity crisis. This is why sound budget planning is so crucial to ensuring the longevity of a company.
A budget shows what to expect for the year ahead in terms of expenses and revenue. In most cases, however, expenses and revenue are not evenly distributed over the course of the year. Expenses and revenue are irregular for all companies, especially new ones. For example, a company may need to purchase equipment, pay employees, fund its sales efforts or receive payment for (long-term) contracts that cannot be billed regularly.
That is why it is so important to draw up a detailed liquidity plan in order to know how much liquidity the company will need at any given time. If your solvency is not ensured at all times, you run the risk of summons, lawsuits and—in the worst-case scenario—bankruptcy. It is estimated that nine out of ten bankruptcies are caused by a liquidity crisis.
Liquidity reserves should not be too big, however, because that money generates little or no interest. If, however, a company runs out of liquidity, it will need to raise money as fast as possible by:
- sending out invoices quickly
- setting shorter payment deadlines
- requesting early and advance payments
- managing customer receivables through factoring
- taking full advantage of credit limits
A company can also hold onto money by:
- negotiating longer payment deadlines
- delaying non-urgent acquisitions
- compressing the production process
- reducing inventory
- postponing maintenance work
- renting or leasing facilities rather than buying them
If that is not sufficient, the company can seek new liquidity by:
- selling facilities that it no longer needs
- increasing long-term debt
- collecting equity capital or outside capital from shareholders
- including personal loans
- reducing private takings