Maintaining the ability to meet short-term obligations and weather operational disruptions or unexpected expenses is a universal need of all businesses – even those with steady cash flow. Sufficient liquidity allows businesses to cover their operating costs, take advantage of opportunities and avoid financial stress.
The importance of liquidity can vary from business to business. Small businesses in Phoenix with low financial reserves might depend more on immediate cash flow to cover operational costs.
Businesses in some industries, like retail and service industries, depend on regular cash transactions and strict inventory management practices to maintain adequate liquidity. Seasonal businesses, including hospitality and event-oriented businesses in the Valley, may rely entirely on liquidity to cover off-season expenses.
Basic cash reserves aren’t necessarily the only source of liquidity for Phoenix businesses. Various high-yield savings tools, short-term loans, and lines of credit are all potential options that allow businesses to access liquid funds to handle the unexpected. However, these sources of liquidity are not equally helpful in every circumstance.
Building liquidity requires deliberate financial planning and a savings strategy with a goal of durable liquidity at its center. This is particularly important for businesses that may experience variable cash flow.
Phoenix businesses can also attack the problem from the opposite side and make themselves less vulnerable to events that might necessitate draining limited liquidity or depending on high-interest financing. For example, modifying accounts receivable practices, holding clients accountable for timely payments, and implementing more stringent cost controls are all ways to enhance long-term liquidity and reduce the risks posed by unexpected emergencies that might otherwise drain limited liquidity.
The ultimate goal should be to avoid scenarios where alternatives to liquid capital may be necessary to maintain operations.
Relying on lines of credit as a temporary substitute for cash may be feasible, but it’s only sustainable if a business has the ability to repay that debt without rapidly generating significant interest costs. Selling off inventory or assets to deal with a temporary liquidity problem can lead to long-term losses, especially if doing so will negatively affect operations. In those circumstances, the solution to the liquidity crisis may be nearly as damaging as the unexpected event that caused it.
Unanticipated Equipment Breakdowns: These can be particularly painful for businesses with limited margins and tight cash flow.
A fryer or walk-in breakdown at a food service business can be potentially disastrous. Both are vital pieces of equipment without which the enterprise cannot operate, making the necessity of fast repair or replacement vital. Although the expense can potentially be covered with financing or lines of credit, the added debt can be a challenge for businesses with constrained cash flow.
Unexpectedly High Utility Costs: Damaged HVAC ducts leading to air leaks, broken thermostats, water heater malfunctions, slab leaks, undiagnosed electrical issues, or workers forgetting to turn off equipment are all potential issues that can lead to unexpectedly high utility bills. Problems that aren’t obvious are the most dangerous, as a drain might go on for weeks before its source is discovered.
Vendor Price Increases: Inflation and supply chain issues often hit businesses with narrow margins the hardest. A steep increase in material or inventory costs can threaten sustainability. While available liquidity can be tapped to compensate temporarily, doing so might not be a sustainable solution. The challenge can be particularly acute if raising prices isn’t feasible due to stiff competition from other businesses in your industry that might be better able to absorb material price increases.
Employee Turnover: Hiring and training new employees is costly in almost every business. The loss of an effective employee can lead to reduced productivity, compounding turnover costs.
Insurance Premiums: Unexpected insurance premium increases, or having inadequate coverage to deal with an unexpected claim, can pose real challenges to businesses. A lack of liquidity to deal with the unexpected cost may jeopardize business sustainability.
Tax Penalties or Compliance Fines: Running afoul of regulators, or the Arizona or Federal Revenue Service, can lead to significant financial penalties for businesses. Meeting deadlines and complying with all regulatory oversight requirements is always preferable, as the cost of doing so is typically less than the penalties that follow.
The consulting and business accounting team at H&H Accounting Services is always ready to assist Phoenix area businesses with the liquidity or cash flow challenges they may be facing. We can identify potential solutions to address limited liquidity, assist with securing financing and identify opportunities to improve cash flow management. Call us at (480) 561-5805 for a free one-hour consultation.
