Liquidity is a company's ability to meet its short-term payment obligations on time. It is like a company's breathing – when it works, no one pays attention to it, but when it fails, everything else stops. A significant number of Finnish SMEs struggle with liquidity, and according to Finnvera, working capital adequacy is the greatest financing concern for SMEs. In this article, I present 10 concrete methods for improving liquidity.
Liquidity Metrics: Quick Ratio and Current Ratio
Liquidity is measured by two key metrics. The quick ratio measures how well a company can cover its short-term debts with assets that can be quickly converted to cash. The current ratio is a broader measure that also includes inventory.
Quick ratio = (Cash + Receivables) / Current Liabilities Excellent: above 1.5 Good: 1.0–1.5 Satisfactory: 0.5–1.0 Weak: below 0.5 Current ratio = (Cash + Receivables + Inventory) / Current Liabilities Excellent: above 2.5 Good: 1.5–2.5 Satisfactory: 1.0–1.5 Weak: below 1.0
According to Statistics Finland, the average quick ratio for Finnish SMEs is approximately 0.9 – at a satisfactory level. This means the average SME cannot cover its short-term debts without liquidating inventory or obtaining additional financing. The target level is at least 1.0, preferably above 1.5.
1. Utilise Invoice Financing
Invoice financing is the fastest way to improve liquidity. It converts accounts receivable into cash within 24 hours without taking on new debt. Since accounts receivable are converted to cash, the quick ratio remains the same or improves, but available liquidity increases significantly. This is especially valuable when large invoices awaiting their due date tie up capital for months.
2. Renegotiate Payment Terms
Payment term negotiation works in two directions. With customers, aim for shorter payment terms: 14 days instead of 30, or 30 days instead of 60. With suppliers, negotiate longer payment terms: request 45 days instead of 30. Every day you gain in either direction improves liquidity. Offer customers a 1–2% cash discount for prompt payment – this is often cheaper than the cost of invoice financing.
3. Strengthen Collections
Overdue receivables are directly deducted from liquidity. Automate payment reminders: the first reminder 3 days after the due date, the second after 14 days. Call the customers with the largest invoices personally. Do not tolerate repeated late payment – tighten terms or require advance payment.
4. Optimise Inventory Management
Inventory is a liquidity trap. Every euro tied up in inventory is missing from the cash account. Analyse sales velocity and turnover time by product. Remove slow-moving products through clearance sales or campaigns – a product sold at half price is better than one sitting in the warehouse for a year. Transition to a just-in-time delivery model where possible. The current ratio improves as inventory decreases and cash increases.
5. Invoice Faster and More Frequently
In many SMEs, invoicing is delayed – in the worst cases, weeks after the work is completed. Every day of invoicing delay is a day taken from liquidity. Implement automated invoicing that sends invoices immediately upon work completion. For long projects, switch to progress billing: invoice monthly or based on milestones.
6. Build a Cash Buffer
A cash buffer is the foundation of liquidity. Aim to hold a sum in cash equivalent to at least 2–3 months of fixed costs. This provides a cushion against unexpected situations – a customer's bankruptcy, equipment breakdown, or seasonal downturn. Build the buffer gradually: transfer a fixed amount each month to a separate reserve account.
Example of cash buffer requirement: Monthly fixed costs: €40,000 Target (3-month buffer): €120,000 Monthly transfer to buffer: €5,000 Time to build the buffer: 24 months Tips: Invoice financing can reduce the buffer requirement because accounts receivable can be quickly converted to cash. In that case, a 1–2 month buffer may be sufficient.
7. Establish a Credit Policy
A credit policy defines who is granted payment terms and how much. Without a clear credit policy, a company may extend long payment terms to risky customers, leading to bad debts and deteriorating liquidity. Set credit limits based on customers' credit ratings. Require advance payment or short payment terms from new customers until their payment behaviour has been verified.
8. Manage Accounts Payable Strategically
Accounts payable are 'free financing' – as long as they are paid on time. Do not pay invoices early unless the cash discount is sufficiently attractive (more than 1% for moving from 14 to 30 days). Utilise payment terms in full: if the due date is 30 days, pay on day 29, not day 15. This frees up cash flow without any cost or risk.
9. Refinance Long-Term Debt
If the proportion of short-term debt is high relative to long-term debt, the current ratio weakens. Consider refinancing short-term loans as long-term ones. For example, converting a working capital credit facility into a 3–5 year loan moves the items to long-term liabilities and immediately improves the current ratio. This is an accounting change that does not alter total debt but improves liquidity metrics.
10. Monitor and Plan Systematically
Improving liquidity is not a one-off project but an ongoing process. Monitor the quick ratio and current ratio monthly. Prepare a cash flow forecast 8–12 weeks ahead and update it weekly. Identify seasonal variations and prepare for them in advance – for example, by activating invoice financing before a quiet period. Set alert thresholds: if the quick ratio falls below 0.8, trigger emergency measures.
Action Plan for Improving Liquidity
Liquidity improvement timeline:
- Weeks 1–2 (quick wins): Activate invoice financing, collect overdue receivables, pay accounts payable only on their due date
- Month 1 (processes): Automate invoicing and collections, renegotiate payment terms in both directions
- Months 2–3 (structural changes): Optimise inventory, establish a credit policy, begin building a cash buffer
- Months 4–6 (consolidation): Implement monthly liquidity monitoring, consider debt refinancing
- Ongoing: Monitor metrics, update the cash flow forecast, respond to deviations immediately
Improving liquidity is one of the most rewarding financial management investments for an SME. It strengthens your negotiating position with suppliers and financiers, enables you to seize growth opportunities quickly, and protects against unexpected setbacks. Start with quick wins – invoice financing and strengthening collections – and progress to structural changes. Within six months, your liquidity should be at a significantly better level.
