Some things in business never change; and this one is an irrefutable constant - cash is king.

A surplus of cash, or liquid assets, puts your business in a better position than your competitors because you can tap into growth potential and weather unforeseen conditions. But, to realize the potential of your cash surplus, you need to understand liquidity management.

Instead of guessing what all the numbers on the various spreadsheets mean, read on to learn about liquidity management and how implementing it in your company is critical for ongoing success!!

Liquidity management offers full transparency into an organization’s cash reserves, liabilities, resources, and spending to ensure it has enough cash to meet its financial obligations, avoiding insolvency. It’s critical when assessing any company’s financial health because it impacts working capital.

In other words, liquidity management is maintaining a strong cash position. Essentially, it’s a risk management strategy that ensures your business’s cash is where it should be at all times.

The risk management process may include:

• Cash flow forecasting (13 Week Rolling Cash Forecast - aka, The Bible)
• Optimizing accounts receivable and accounts payable processes
• Managing short-term debt and investments
• Assessing lines of credit

Some factors that impact liquidity include:

• Inventory
• Outstanding Payables
• Outstanding Receivables
• Inferior Credit Limits & Compressed Availability
• Seasonality

There are multiple measures you can use to assess and predict liquidity. Some of the best include:

• Cash ratio: divide cash and cash equivalents by current liabilities
• Current ratio: divide current assets by current liabilities
• Quick ratio: divide current assets (cash, securities, and accounts receivable) by current liabilities
• Days cash on hand:  divide cash on hand by (annual operating expenses - non cash items/365)
• 13 Week Rolling Cash Forecast - aka, The Bible

There are three primary types of liquidity. They are:

• Accounting liquidity: ability to meet day-to-day operational costs, like payroll and inventory
• Asset liquidity: assets you can easily convert to cash without incurring a significant loss, such as short-term debt instruments and cash on hand
• Market liquidity: high market liquidity means there are many buyers and sellers, and asset prices are stable

Accounting liquidity is the most important type because it directly impacts your business’s solvency. Yet, market liquidity is essential when making investment decisions, especially during a season of volatility.

Let’s put this into the context by making an assessment of a bank’s liquidity.

Banks receive money from loans and profit from interest rates, but they also invest in bonds and securities. Even though rising interest rates give banks more incoming cash, their assets lose value, causing a disruption.

Thus, banks and other financial institutions use a contingency funding plan (CFP). A CFP links stress test results and additional information as inputs to governance and decision frameworks. This allows them to address high-impact, low-probability events.

Considering the drastic rise in inflation and interest rates over the last several years, the CFP would’ve been essential to help financial institutions weather the new economic conditions. Further, one of the roles of the Federal Reserve is to manage inflation by boosting capital market liquidity.

These tools have allowed many financial institutions to profit during economic uncertainty.

Liquidity planning is not a one-size-fits-all process. But generally, the first step in liquidity risk management is establishing data collection and forecasting tools.

Key data sources include:

• Bank intraday reports (aka, Daily Cash Flash)
• 13 Week Rolling Cash Forecast (aka, The Bible)
• One-off payments
• Tax payments

Tools that track bank accounts will allow you to gather this information quickly. When possible, use actuals instead of estimates for best results.

Next, determine expected internal flows so the treasurer can state the company’s net position. This sets the liquidity position for the day (surplus or negative).

If the company has a surplus, it may use the cash to pay off debt, especially to lenders with higher interest rates. It may also decide to invest in a money market. If the company is negative, it may need to access a line of credit, get a loan, or sell investments.

Your organization should make these decisions in advance within a set framework to avoid risking its principles.

And if you want to operate globally, you need to think about how to fund the liquidity of foreign subsidiaries. Different governments have various rules regarding liquidity structures you must follow.

By implementing these highly effective liquidity management strategies, your organization will experience more success. This is because liquidity management directly relates to your company’s profitability.

Schedule regular meetings to review and revise payment terms. You always want to clearly define the terms so that they directly and positively impact liquidity management. Failing to do this creates unnecessary risk.

If you need to incentivize customers to pay faster, try using discounts or negotiate pricing. You can negotiate sales volumes if your business needs more time to pay vendors.

Work with customers to switch them from check payments to digital payments. There are plenty of reliable digital options customers can use that will make payments easier for all parties. Some examples include:

• Automated Clearing House (ACH)
• Same Day ACH
• The Clearing House RTP® network

You can use a payment menu to move providers to your preferred method.

However, although digital payments don’t guarantee you’ll receive cash faster, you can recognize and post incoming transactions sooner.

Employing new electronic tools is essential to use old technology with new real-time data solutions.

For example, integrate payment solutions with existing ERP infrastructures or treasury management systems. This integration reduces costs. It also includes security protocols and regulatory compliance.

Further, dashboards are a powerful tool that assists with cash management.

You could be trapping cash and not even know it. If so, your business may experience a cash flow crisis.

Trapped cash often happens from manual processing because it creates limited visibility into expenditures and income cash transactions.

Increasing liquidity visibility highlights where your business has trapped cash that you can free for better use.

If you lack visibility into your cash flow, you’re creating risk. To reduce risk, try the following:

• Manage cross-currency transactions to predict cash inflow or outflow better
• Monitor the business strength of your suppliers and vendors
• Use technology solutions to automate payment tracking

Creating a liquidity management strategy is crucial for business growth. Without one, you risk not being able to meet your financial obligations, which could cause your business to fail.

For help building a robust liquid management strategy, contact us today at The William Stanley CFO Group. With our extensive liquidity optimization experience, our team can optimize your company by managing risk and increasing value.