How can an economic downturn affect a company’s liquidity?

An economic downturn can significantly impact a company's liquidity primarily by tightening credit conditions. During such periods, financial institutions often become more risk-averse due to increased uncertainty and potential default risks. As a result, access to credit becomes more restricted, which means that companies may find it difficult to obtain financing to cover operational costs or invest in new opportunities. This can lead to a cash flow crunch for businesses, making it harder for them to meet short-term obligations, pay suppliers, or sustain their operations.

A tightening of credit conditions limits the available capital for both new and existing loans, reducing the liquidity available to businesses. Consequently, firms may have to rely more heavily on their internal cash reserves to navigate the challenges posed by the downturn, further stressing their liquidity position.