What Are the Problems Created by Liquidity Shortage in Finance Development?

by Quentin Webb; Updated September 26, 2017

Finance development problems caused by liquidity shortage may make it difficult for a business to expand its markets and pay its suppliers and workers. Liquidity is the amount of cash and short-term assets easily converted into cash. A shortage of cash assets not only affects business operations but also creates problems for the development of finance, which will lead to operational issues.

Liquidity Shortage Profiles

Some larger businesses have slim liquidity balances as the result of conscious management decisions. They have developed a bank finance cushion to lean into when a quick injection of cash is required. This enables them to use business cash for market expansion. However many smaller businesses have liquidity shortages because market sales are slow, worker productivity is deficient or declining, accounts receivable are slow paying, or inventory is too high. For these smaller businesses, a liquidity shortage creates significant finance development problems.

Finance Development Problems

Unplanned liquidity shortages create many issues such as slow payment on supplier accounts, difficulty paying wages, and deferred market expansion plans. Even business stock market prices may be depressed as investors look for companies with solid cash reserves. But one of the biggest problems is the inability to develop a network of business finance alternatives for both short- and long-term finance needs.

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Businesses Need Access to Finance

Businesses need liquidity for many reasons, and to get cash, they need access to quick credit sources of cash. A business with an unplanned and ongoing liquidity shortage will find it difficult to develop a bank line of credit, business credit cards, and favorable supplier payment terms. Many suppliers provide merchant credit to businesses, which would be hard to get with liquidity problems. A bank line of credit may be impossible to get as well. If liquidity problems have led to slow debt repayment, the business credit rating and score may be adversely affected.

Liquidity Effects Long Term Finance

Finance development includes long-term as well as short-term credit needs. Long-term credit funds may be needed for equipment expenditures, product development and market expansion. The ability to get long-term loans and funds will be seriously impaired if liquidity shortages have led to low credit ratings and scores. Bond and stock markets may no longer be viable alternatives for funds. Secured bank loans may not be accessible. Even home equity loans may become difficult to get.

The most disastrous aspect of liquidity shortage and its negative impact on finance develop is that it become a self-feeding process with liquidity shortages leading to inaccessibility to credit and finance funds, leading to further liquidity shortages with an ensuing downward spiral.

About the Author

After 20 years as a business consultant, Quentin Webb began publishing articles on small-business issues in 2006. He has worked with banks and the Small Business Administration, and his articles have appeared on various websites, covering topics ranging from niche markets to nutrition. Webb earned a Ph.D. in business and economics at Southern Methodist University.

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