Will you still be solvent in ten weeks’ time?

Using Solvency as a KPI

Trade wars and protectionism, geopolitical uncertainties, but also pressures closer to home, such as increasing payroll and energy costs, don’t just have a tight grip on the German economy. Payment practices are deteriorating and liquidity is no longer to be taken for granted. What might have been dismissed by many as a superfluous luxury in times of economic growth becomes a survival strategy in a slowdown. Only those who can foresee imminent insolvency will be able to do something about it.

But how, given the complexity of global interconnectedness, can you keep track of everything?

Managing businesses in periods of stagnation

Businesses that are involved in many different relationships as suppliers or that are dependent on consumer spending will be among the first to suffer from a weak economy, not to mention a recession. Solvency as a KPI is gaining in importance. Those who do not have a large financial cushion are reliant on the proceeds from current orders. If incoming payments are late or accounts receivable remain outstanding, it won’t be very long before their own solvency is affected.

Since payment defaults make themselves felt so quickly, any deteriorating payment practice on the part of customers requires countermeasures designed for the short term. Liquidity as a KPI enables you to look at a time frame of just a few weeks into the financial future of your business. The short-term nature of this benchmark also offers a very high degree of agility.

Defining liquidity as a KPI

Liquidity is measured as the difference between outstanding receivables and one’s own liabilities, taking due dates into account. That sounds simple. However, the more customers and orders a business has on its books, the more difficult and time-consuming it becomes to obtain an overview of receivables, payables and payment terms. This applies to e-commerce, for instance, but also to businesses in the housing industry with several hundred residential units and monthly incoming payments.

In order to use liquidity for management purposes, the KPI must be updated every day. This is where automated liquidity management provides the necessary speed for a quick overview. If you need to analyse at great length first, you will have frittered away the time in which to act.

The three ways of fine-tuning liquidity

Once you have identified an imminent liquidity bottleneck, make good use of the remaining time. Check whether just one of your business accounts is affected while another is in credit. If all funds have already been redistributed, you still have three ways of fine-tuning your liquidity.

  1. Manage your accounts receivable
    Display your overdue receivables and issue requests for immediate payment. Start by approaching the debtors who have exceeded the payment deadline by the most and who have the largest amounts outstanding.
  2. Appeal to business ethics
    Do your customers regularly exceed payment deadlines? If so, identify the offending debtors using smart liquidity management. You can then urge those customers to comply with their payment terms in future.
  3. Make the most of payment terms
    If the staff in your accounts department always settle invoices several days before they are due, have them take advantage of the payment terms from now on. In an emergency, salaries can be paid a few days later too. If the delay is going to be longer, timely communication is advisable.

When measuring your liquidity, consider your customers’ payment history as well. If customers always pay a few days after the due date, you should wait until then before introducing the steps mentioned above.
And if the worst comes to the worst? If insolvency can no longer be averted, a reliable history and evidence of your minimum liquidity requirement will help you to secure a bridging loan.

Solvency – more important than profit?

Sound business management includes financial and liquidity planning. But which is more important? All are agreed on this point: especially in times of growth, losses are considered almost to be good form. On the other hand, liquidity is what determines whether your business will continue.
So be sure to keep a watchful eye on your solvency – not just in periods of stagnation.