Understanding Liquidity vs. Profitability

Is Your Business Actually Healthy? Understanding Liquidity vs. Profitability

Financial jargon can make anyone’s head spin: but at the end of the day, managing a business comes down to two simple concepts: how much cash you have right now and how much you’re keeping at the end of the month.

Understanding the difference between liquidity and profitability is the secret to surviving turbulent times and knowing if you’re actually winning the game.

Liquidity: The “Cash is King” Rule

Liquidity is essentially your “walking around money”. Accountants define liquid assets as things that are already cash or can be turned into cash almost instantly.

  • What’s Liquid: Your business checking and savings accounts are the ultimate liquid assets.

  • What’s “Sort of” Liquid: Receivables that customers owe you and are scheduled to be paid very soon.

  • What’s Not Liquid: Your office furniture, computers, and heavy machinery: these have value, but it takes way too long to turn them into usable cash.

Why it matters: When business gets turbulent, liquid cash allows you to move fast to solve problems or grab new opportunities.

Profitability: Is the Bottom Line Positive?

Profitability is the most basic measure of success: is the money coming in greater than the money going out? When you look at your income statement, you want that net profit number at the very bottom to be a positive number.

If you want to grow that number, you have two main levers to pull:

  1. Increase Gross Profit: Focus on bringing in more from your core sales.

  2. Decrease Overhead: Cut down on those indirect expenses that eat your margins.

How Do You Know if Your Numbers Are “Good”?

A positive number is a start, but you need to benchmark your performance against others in your industry.

  • The Service Business Standard: A healthy service business should generally see profitability between 10% and 20%.

  • Check the Competition: Look to trade associations or even friendly competitors to see how your percentages compare to theirs. That is the real way to tell if you’re doing well.

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