Profit is positive difference between revenue and costs. If this difference is negative (i.e. if costs exceed revenues), it means that a business is experiencing loss.

Liquidity means the extent to which an organization is able to convert its assets (items of monetary value owned by the business) into cash. Liquid assets are those that can be converted into cash quickly and without negatively impacting its market value. Examples of liquid assets include:

• Cash (including deposits at a commercial bank)

• Debtors

• Stock (inventory).

By contrast, illiquid assets are items of monetary value owned by a business that cannot be converted into cash as easily or quickly. Examples of illiquid assets include:

• Property

• Plant (production facilities)

• Equipment.

The liquidity position of an organization indicates the extent to which it has sufficient liquidity to continue its business activities. 

• Good liquidity position -> business can avoid bankruptcy (business closure) as the organization has sufficient liquidity to continue operating. 

• Poor liquidity position -> may struggle to cover its current liabilities. If the business is not able to improve its liquidity position, this can eventually lead to bankruptcy.

  • • A liquidity problem (or cash flow problem) occurs when there is a lack of cash in the organization because its cash inflows are less than its cash outflows, i.e., it experiences negative net cash flow.

The liquidity position of a business is important as it shows its ability to repay short-term liabilities without having to rely on external sources of finance, which could dilute ownership and control and/or incur debt interest payments. 

The main method of measuring a firm's liquidity position is liquidity ratio analysis.

• Current ratio

• Acid test ratio (also known as the quick ratio)

Closing balance is the amount of cash at the end of a trading period. 

Closing balance = opening balance + net cash flow for the month

If you are a creditor (you sell products to your debtors and let them pay later), then you might shorten credit period (the time period within which your debtors are obliged to pay). 

• Advantage: receive cash payments earlier. 

• Disadvantage (-): the relationships with debtors might deteriorate and they might be looking for new suppliers.

If you have too many debtors or even bad debt (a situation when you aren’t able to get payment for your products) then you might use a source of finance that is called debt factoring. 

The way it works is debt factor buys debts from you in exchange for a fee. They they get the money when the debtor pays.

• For example, A owns $100 to B by next year. 

• If A needs cash urgently, then debt factor may pay $90 to A right now and collect the debt from B in the due time, earning $10. 

• On the one hand, A might get cash payment earlier and improve working capital. 

• Disadvantage (-): A won’t get full payment because debt factors always work for a fee that is a certain percentage of the debt.

If cash flow forecast shows the periods when cash is insufficient, then the organisation might plan an overdraft beforehand. 

Advantage: easy to obtain cash using overdraft: the procedure is usually simple and quick. 

Disadvantage (-): delayed overdraft repayments have enormous interest rate, so it is better not to delay overdraft payments to avoid the risk of overpaying.

Works is by selling non-current assets and leasing them back immediately. 

• For example, a restaurant sells its pizza oven to someone, but this pizza oven is leased by the restaurant immediately at the time of purchase. 

  • It never has to leave the restaurant. The only thing that’s changed, is that restaurant is no longer the owner of that pizza oven and it has to lease it from the new owner, paying a fee every month for using it. 

Advantage (+): in the short-term, you have significant cash inflow for selling a non-current asset. 

Disadvantage (-): in the long-term, you lose ownership over your asset and you have to pay for using it every month.

If you are a debtor, you may ask your creditors (suppliers) to postpone payment for you, i.e to increase credit period. 

Advantage (+): you are delaying cash outflows. 

Disadvantage (-): you might be ruining relationship with creditors.

Advantage (+): you’ll decrease the outflows and will retain more cash. 

Disadvantage (-): “cheaper” often means “worse”, so the quality of produced goods may deteriorate.

This can be any overhead (indirect cost): internet fee, advertising costs, coffee machine in the office, etc. 

Advantage (+): Cutting some of the expenses will release some cash

Disadvantage (-): might also result is staff demotivation (if you take away the coffee machine, haha), or decreased brand awareness (if you cut advertising costs).

hire purchase — a source of finance that allows to pay for the purchase of non-current (long-term) assets in several instalments, as opposed to one-off payment. 

This way, if the organisation is in need of some non-current assets (machinery, equipment, etc.) but does not want to spend too much cash at once, payment may be broken down into several smaller instalments. 

Advantage (+): first payment is lower than paying full price at once. 

Disadvantage (-): in the long-term, it means that there will be regular cash outflows monthly and the overall sum paid is usually larger than with the regular one-off purchase.

Advantage (+): you save more cash and maintain a sufficient working capital.

Disadvantage (-): you are not getting any non-current assets at all.

Keeping high levels of stock (of finished goods or raw materials) is expensive because it takes substantial place, it should be insured, it should be stored securely, the appropriate temperature needs to be maintained… 

The extreme idea is to use just-in-time production, that we’ll talk about in Unit 5, when there are no stocks at all. 

Advantage (+): frees up some cash and improves working capital. 

Disadvantage (-): keeping insufficient stocks might result in not being able to sell enough goods to customers, when there is high demand, thus missing an opportunity to make profits.