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Cashflow and liquidity

Successful businesses proactively monitor cashflow and liquidity.

Most business owners understand what cashflow is but are less sure about the best way to manage it and do not understand the concept of Working Capital/Liquidity.

Working Capital/Liquidity is basically what cash you have to work with on a day-to-day basis. On the positive side you have:

  • Stock
  • Work In Progress (WIP)
  • Money in the bank
  • People who owe you money


Other the negative side you have:

  • People you owe money to
  • VAT and tax


To manage cashflow you really need an accounting package. To manage your Liquidity you need regular management accounts.

The accounting system we recommend in Xero because this has a Dashboard which gives you a very good snapshot. And, because Xero is online I can easily get access to the data I need to manage your VAT and work out and tax you need to allow for on profits.

So many people make the mistake of taking too much money from their business or making the wrong funding decision on buying things for their business because they forget to allow for tax.

To get a feel for the short-term cash availability/liquidity you can use two ratios called the a) Current Ratio and b) Quick Ratio. These are fairly straight forward ratios, easy to calculate, but they can tell an important story.

The Current Ratio is the total of your “Current Assets” divided by your “Current Liabilities”. These are found on the top half of your Balance Sheet. If you’ve got a number of more than 1 it means that your current assets are greater than your current liabilities. That’s good.

It makes sense to track this regularly and create a graph because if you’ve got a downward trend in your Current Ratio then that suggests that you’ve got a potential problem. Specifically it means that at some point you are not going to service all of the short-term debt.

The Quick Ratio excludes Stock and Work In Progress. This is because it takes time to turn stock and Work-in-progress into cash. This will give you the worst case short-term cash position.

Another useful ratio to monitor if you sell on credit is called Debtor Days. Debtors are people who owe you money and to work out the ratio divide your debtors today by gross sales and multiply the answer by 365.

Once again, track and graph the results because small changes can make a big difference to the cash in your bank.