What is Liquidity Management?
Liquidity management is the strategy an organization employs to refine, expand and secure its liquidity. In other words, making sure cash is in the right place at the right time.
Why is this important? The health of an organization is measured by its liquidity, which may equate to how quickly it can access the debt/capital/loan markets and/or how much cash it has on hand (short-term). Either way, it’s about an organization’s ability to quickly and efficiently pay off its debt and short-term liabilities (e.g., payroll).
Liquidity is something we see highlighted in times of global crisis, such as the Great Recession or the pandemic lockdowns of 2020. But it’s also integral to the day-to-day life of an organization, as it informs critical decisions such as whether or not to invest in an expansion or new project, or whether or not a lender will grant your organization a loan. When done well, there is full transparency into the organization’s spending, cash reserves, liabilities and resources.
It’s a complex and multi-faceted exercise with two primary considerations: short-term assets and medium- or long-term assets. Treasurers need to know how quickly they can turn their short-term assets — which include cash on hand, cash equivalents,
accounts receivable, and short-term investments — into cash. Knowing the timing around liquidating their medium- and long-term assets is also essential, which may include fixed assets (e.g., property, equipment).
How Companies Manage Liquidity
There are a number of ways to approach liquidity management and a number of different inputs and cash flows. Establishing the data collection tool (e.g., spreadsheets) and forecasting tool your company will use is the first step.
Where will you get the data? Key data sources include the bank intraday report, which details daily collections; tax payments and one-off payments; disbursement outflows and payroll. The last two are derived from the bank reporting feeds, which detail what is collected and what is disbursed.
The company then determines any internal flows it can expect, such as payroll, tax payments, large customer receipts or other payments internally noted. During the day, the treasury department gathers the details and the company’s net position is determined. A decision is then made on what to do if there is a surplus or negative amount of cash in a bank account overnight. This determines the company’s cash/liquidity position for the day.
Selecting liquidity options within certain risk parameters is strategic. Deciding what to do with a negative or surplus daily cash position should be defined by a set of parameters. Surplus cash could be used for such pursuits as funding short-term investments or paying down debt and bank lines of credit. In the event that cash is needed, what solutions are available to you? Does your company have access to bank lines of credit, or could you issue commercial paper, sell investments or obtain a short-term loan?
This should all be decided in advance so, from a risk perspective, you know what your company is comfortable with. The immediate goal is to never risk principal. Longer term, you want to help the organization meet its obligations with longer dated capital markets activity. Overall, it’s about selecting providers for short-term financing, investments and longer-term financing options, all within a set framework. Thinking on a global scale, this is a first step toward companies operating globally — funding the liquidity of their foreign subsidiaries. The primary difference between regions, for example the Asia-Pacific region and the Middle East and Africa region, is a restriction on currency by the governments of different countries. While some offer the ability to operate in cash pools, netting structures, or as part of an in-house bank, others, such as India, are much more controlling of their currency and don't allow these liquidity structures.
Setting the liquidity position is a daily process. One key decision here is to determine who to interface with internally and externally. Let’s take a closer look at the sources of the liquidity inputs, both internal and external, to help you make that decision.
- Accounts Payable: Money owed to vendors and suppliers for goods and services.
- Accounts Receivable: The credit sales of a business (goods and services) that have not yet been collected (i.e., money people owe you).
- Payroll: The entirety of all earnings owed by a business to its employees over a specific time period, to be paid on a certain date.
- Tax: Mandatory contributions to fund government (local, state, federal) expenditures and programs, which may include payroll taxes, federal and state income taxes, and sales taxes.
- Procurement: This is the process of a business purchasing goods or services, and is determined through a procurement budget, which informs management of the amount they can spend to acquire the goods and services they need. Why is this important? Because whether a business is able to purchase the goods or services it needs can have a direct impact on the profitability of its operations.
- Bank Portal: Banks provide a portal through which treasurers can view their liquidity across multiple bank accounts and currencies in real time.
- Aggregator Tool: A tool banks provide that allows customers a dashboard view across their full investment portfolio to help monitor and control liquidity risk exposures and manage funding requirements, accounting for security types, country and regional exposure and risk, and the weighted average yields and maturities. This can be used for one bank or multiple banks
- TMS (treasury management system): A software system that automates treasury operations — allowing for greater visibility of your company’s cash and liquidity — and incorporates and consolidates data from multiple sources.
At the end of the day, your goal is to have a set threshold as a buffer in case activity comes through after the daily cutoff time. Knowing cutoff times for investing and divesting, commercial paper issuance and short-term financing, as well as times for collections, disbursements, and any other payment file cutoffs helps determine the best time to establish the liquidity position. Other key decisions and tasks include:
- Selecting investments to hold excess liquidity.
- Selecting short-term financing providers and their options.
- Working with your primary bankers.
Global Liquidity Structures
For treasurers in international businesses, the challenges involved in managing cash are multiplied by the complex nature of international regulation and varying local banking practices around the world. The core challenge for all treasury practitioners is to ensure visibility of their group’s positions globally. Having clear knowledge of each operating entity’s cash position can help to ensure it is funded as economically as possible, and that any surplus cash is invested safely. Additionally, complete and accurate visibility into cash positions helps the group treasury to identify how the group is exposed to risk and develop strategies to manage those exposures.
Tools available to multi-national companies for liquidity management involve establishing a cash pooling structure at a basic level, as well as managing liquidity through an in-house bank with intercompany loan structures and repatriating cash back to the parent entity. Let’s take a closer look at these two tools.
A cash pool is a liquidity management technique that allows surplus cash generated in one part of the business to be shared to other group entities with a cash requirement. This works in organizations where group entities are at different stages of their product lifecycles; for example, one entity might have a product in development, while another has brought a successful product to market. It also applies where a company’s sales operation in one country is fully established, and it’s investing in building a market in a new jurisdiction. Most companies typically organize them by separate legal entities, which are often defined by different business units.
There are two main forms of cash pooling: physical cash pooling, where funds are moved from one bank account to another (typically known as the header or master account), and notional cash pooling, where there is no movement of funds within the structure.
Fundamentally, an in-house bank (IHB) provides banking services to participating group entities. The precise structure varies between organizations, but it’s common for group treasury either to act as the IHB, or to establish a new entity to do so. The location of the IHB should be in a tax-efficient and geographically convenient location where it has access to external banking partners and other financial institutions.
The most common type of in-house banking structure is one in which the IHB provides the full range of banking services to all participants which are the business entities. All participants hold accounts with the in-house bank, which are then denominated in each entity’s operating currency, and all intra-group payments are routed through the IHB. In some circumstances, external payments to suppliers and collections from customers are also routed through the IHB. It also provides funding to group entities and invests surplus cash on their behalf, initially via a group cash pool and then with the external market, which allows for more efficient foreign currency purchases as well.
With organizations more focused on cash than ever before, finance is under pressure to operate as efficiently as possible. Making best use of the available technology is naturally seen as one way to do so. In an environment in which there is constant innovation, with different fintech companies promoting their individual solutions, it can be difficult for finance professionals to identify the best technology for their organization.
AFP hosted a webinar, “LIBOR Transition: Preparing for the End Game,” with three corporate finance experts who spoke on the transition of Libor. The speakers included Peter Phelan, president of Phelan Advisory LLC and former (as of March) deputy assistant secretary for Capital Markets at the U.S. Department of the Treasury; Mack Makode, vice president and treasurer at Under Armor; and Matt Johnson, vice president and treasurer at Genesco.