With 29% of the startups failing because they run out of cash, it’s important for startups to manage their liquidity carefully. The cash flow cycle is the lifeblood of any business, and startups are especially vulnerable to cash shortages as they typically don’t have large reserves or access to long-term financing.

Without sufficient liquidity, startups may struggle to pay their bills on time and manage the business’s daily operations. It can ultimately lead to financial problems and even bankruptcy. Let’s look at this in more detail below.

What Is Liquidity In a Business?

Liquidity refers to the ability of a business to meet its short-term obligations with ease. It is an important aspect of any financial plan and should be closely monitored by business owners.

Liquidity is typically measured using a current ratio and quick ratio, which measure the ability of a business to convert its current assets into cash to meet its short-term liabilities. Businesses that have sufficient liquidity can easily pay their bills and obligations when due.

Meanwhile, those with inadequate liquidity may struggle to make payments on time or be forced to liquidate assets to pay creditors. Liquidity is of utmost importance for startups because they typically don’t have access to credit, so they must rely on their own resources to meet operating expenses.

Importance of Liquidity Management for Startup Valuation

Liquidity management simply means managing the company’s existing cash flow. It is an important factor for startup valuation for several reasons:

Assessing Financial Health

Liquidity management helps startups assess their overall financial health. Companies that are able to keep a healthy cash flow are more likely to attract potential investors and secure financing. This, in turn, will help increase the company’s value and make it more attractive to potential buyers.

Managing Risk

A seamless cash flow helps startups manage their risk. Startups must ensure that they have adequate funds available at all times to cover any unexpected expenses or losses. It includes having sufficient funds for payroll, taxes, and other expenses. Without proper liquidity management, startups are at risk of running out of money.

Securing Funding

Every startup needs a certain amount of capital to launch and sustain its operations. Liquidity management helps startups secure the necessary funding they need to get off the ground. It also helps them to determine how much money they need to acquire and what sources of financing are available.

Optimizing Spending

Startups have to be very careful with how they spend their money. It is important to properly manage liquidity so the company can ensure it has enough cash to survive and handle any setbacks.

Role of Liquidity In Business Valuation

When calculating a business’s value, one important factor to consider is liquidity. Typically, a business with higher liquidity is more valuable than one with less liquidity.

Liquidity measures how easily an asset can be converted into cash and is an important factor in assessing the value of a business. It affects the ability of a firm to meet its short-term obligations, pay dividends, and reinvest in the company.

Let’s take two scenarios. Company A has a large number of liquid assets, such as cash and marketable securities. Meanwhile, Company B has fewer liquid assets such as property, plant, and equipment.

In this case, it is easier for Company A to secure funding. Potential investors can easily see the value of the liquid assets and can use them as collateral. That makes Company A more attractive to potential investors, thus increasing its value.

Liquidity of Assets

When determining the liquidity of assets, it is important to consider how quickly and easily the asset can be converted into cash. Per that criteria, you can divide assets into two types.

Most Liquid Assets

These assets can be easily converted into cash. Examples of these assets include:

• Stocks and bonds
• Money market accounts
• Certificates of deposit
• Inventory
• Cash receivable

Least Liquid Assets

These assets are somewhat more difficult to convert into cash. Examples of these assets include:

• Real estate
• Trademarks
• Equipment
• Intangible assets

How to Avoid Liquidity Risks?

As a startup, one of the biggest challenges you will face is liquidity risk. Liquidity risk is when a company does not have enough cash reserves to cover its expenses and liabilities. There are a few steps you can take to help manage liquidity risk:

Monitor Cash Flow

Keep track of your cash flow and make sure there is a consistent inflow of cash to cover your expenses. Then, create a budget and follow it closely.

Improve Debt Management

If you have existing debt, work to reduce the amount of interest you are paying on it. Seek out low-interest loans or seek investment from other sources.

You can also look into refinancing options if you have a large amount of debt that needs to be paid off.

Increase Savings and Investing

Save money when you can and invest in low-risk investments. It will help you create a reserve of funds that can be used in case of an emergency.

For instance, you can invest in liquid assets like mutual funds, stocks, and bonds. Here are some ways to save money in your startup:

• Utilize cost-cutting measures to reduce expenses
• Take advantage of tax breaks and credits
• Negotiate better rates with suppliers and vendors
• Look for grants and subsidies

Finally, review your liquidity risk management plan regularly. Assign a team to monitor the cash flow of your business.

Evaluate Business Strategies

Evaluate your business strategies regularly to ensure that they align with your financial goals. Make sure the strategies are sound and properly planned out, as well as cost-effective.

Suppose you’re an e-commerce business. Which are the most recent and popular trends in the market? Consider implementing those strategies to boost your sales and increase customer loyalty.

Seek Professional Help When Required

Liquidity management can be tricky business. If your startup has limited resources, you may want to consider seeking professional help from an accountant or financial advisor. They can provide valuable guidance on how best to manage your liquidity.

As for presenting your liquidity in a financial model, Numberly can help. We create custom financial models ready for any pitch or your next quarterly forecast. Schedule a call with us to learn more.