Every business owner knows the feeling. A key client pays late, a delivery truck breaks down and SARS is due, all in the same week. Profitable businesses fail in moments like these, not because they’re losing money, but because they can’t get to cash fast enough.
The answer is a commercial capital buffer: cash and quick-access funding set aside before you need it. To build one, you need to understand three things: liquidity, liquidity risk and retained earnings.
What is liquidity?
So, what is liquidity? Liquidity is how quickly and easily your business can turn its assets into cash to pay its short-term bills.
Cash in the bank is perfectly liquid. Money owed by customers is fairly liquid, depending on how fast they pay. Stock is less liquid, because it has to be sold first. Property and equipment are illiquid. They may be valuable, but you can’t pay salaries with a forklift.
A business can be asset-rich and still have poor liquidity. That’s why asking “what is liquidity?” matters as much as asking “are we profitable?”
What is liquidity in numbers?
Two simple ratios answer the question of what is liquidity for your business in practice:
- Current ratio = current assets ÷ current liabilities. Above 1.5 is generally comfortable. Below 1.0 means your short-term debts exceed your short-term assets.
- Quick ratio = (current assets − stock) ÷ current liabilities. This strips out stock to show what you could pay right now. Around 1.0 or higher is a healthy sign.
Check both ratios monthly. A steady decline is an early warning long before the bank balance hits zero.
What is liquidity risk?
Liquidity risk is the risk that your business can’t meet its financial obligations when they fall due, even if it’s profitable on paper.
For South African SMEs, liquidity risk usually shows up in a few predictable ways:
- Late-paying customers: large clients stretching 30-day terms to 90 days or more.
- Customer concentration: one big client getting into trouble and taking your cash flow with them.
- Unexpected costs: equipment failure, generator and backup power costs, or a sudden tax bill.
- Rapid growth: bigger orders that need cash upfront before the income arrives.
- Seasonal swings: quiet months where fixed costs carry on as usual.
The tricky part is that it builds quietly. Our guide to the unexpected expenses every SA business should plan for shows how quickly small surprises add up.
How to measure your liquidity risk
The simplest way to answer what is liquidity for your own business is one question: if all income stopped tomorrow, how many weeks could the business keep paying its fixed costs?
Add up your monthly fixed costs: rent, salaries, loan repayments, insurance and software. Then divide your available cash by that figure. If the answer is less than one month, your exposure is high. Two to three months gives you breathing room. Six months is a strong position.
What is retained earnings, and how does it help?
Next, what is retained earnings? Retained earnings are the accumulated profits your business has kept over time, rather than paid out to shareholders as dividends.
On your balance sheet, retained earnings sit in the equity section. They grow each year you make a profit and keep it in the business. They shrink when you make a loss or pay dividends.
Here’s a common misunderstanding when people ask what is retained earnings. Retained earnings are not the same as cash. A business might show R2 million in retained earnings but have spent most of it on equipment, stock or paying off debt. The profit was earned, but the cash may be tied up elsewhere.
So when you ask what is retained earnings worth to your buffer, the answer depends on what you’ve done with it.
How retained earnings build your capital buffer
Once you understand what is retained earnings, the link to your buffer is clear. Retained earnings are the most natural source of a capital buffer, because the money is already yours. No interest, no repayments, no lender approval. The key is to deliberately keep some of that profit liquid.
A simple approach:
- Set a buffer target. Aim for two to three months of fixed costs to start.
- Ring-fence a percentage of profit. Before dividends or big purchases, move 10% to 20% of monthly profit into a separate business savings or call account.
- Keep it accessible. Choose accounts where you can reach the money within days, not months.
- Rebuild after use. If you dip into the buffer, make topping it up a priority.
For guidance on the right size of buffer, see how much your business should keep for emergencies.
Pair your cash buffer with a funding partner
Even a well-built cash reserve has limits. A big contract, a major equipment failure or a long payment delay can outrun any savings account. That’s why the strongest liquidity plans combine two layers:
- Your own cash buffer, built from retained earnings, for everyday shocks.
- Access to external funding, arranged in advance, for larger gaps and growth opportunities.
The worst time to look for finance is when you’re already short. Lenders see a business in distress, and your options shrink. Setting up a funding relationship while your liquidity is healthy gives you speed and better terms when you need them most.
Quick answers
What is liquidity in simple terms? It’s your ability to pay short-term bills on time, using cash or assets you can quickly turn into cash.
What is the biggest cause of liquidity risk for SMEs? Late customer payments, especially when one client makes up a large share of income.
What is retained earnings, in one line? The profit your business has kept over time instead of paying it out as dividends.
What is retained earnings used for? Reinvesting in growth, paying down debt or, ideally, building a cash buffer.
Is high profit the same as good liquidity? No. A profitable business can still run out of cash if its money is locked in stock, debtors or equipment.
Build it before you need it
Knowing what is liquidity, keeping an eye on liquidity risk and understanding what is retained earnings and how to use it are the foundations of a resilient business. A buffer won’t stop the tough weeks from coming, but it’ll stop them from becoming a crisis.
GroWise Capital partners with South African SMEs to keep growth funded and liquidity risk under control, so you can focus on running the business.