Cash and liquidity management

Liquidity is access to cash. Its management is the most fundamental element of treasury management — if it fails, the organization cannot continue to function.

Cash and liquidity forecasts

Liquidity enables an organization to do two things: to pay its obligations where and when they fall due; and to source additional funds to meet further obligations. Successful liquidity management therefore depends on having an insight into the business’s future cash-generation or absorption – a cash forecast. Cash forecasts are fundamental to a liquidity strategy, with the treasurer often looking ahead over several timeframes to manage liquidity.

Liquidity risk can be analyzed by time frame:


Liquidity risk can be analyzed by time frame:

  • Operational liquidity risk focuses on short-term needs arising from day-to-day operations
  • Strategic liquidity risk focuses on longer-term risks and the need to ensure that the business can continue and can support changing business plans in the future.

Day-to-day cash forecasts are usually driven by receipts and payments data from the accounts receivable and payable ledgers, interest and tax information, and net profit/performance reporting. They generally cover the period from the day they are created until up to 30 days later. While treasurers in highly geared or volatile businesses often value them greatly, some of their peers in cash-rich or cash-generative businesses do not use short-term forecasts at all. However, the need to optimize the investment of surplus cash means more companies are requiring them today than in the past.

Medium-term forecasts often extend to a ‘rolling’ year. They allow the planning of ‘big ticket’ items such as capital expenditure, tax and dividend payments and funding maturities. They feed into some aspects of forecasting compliance with financial covenants. These forecasts are based on stress-tested business plans and only attain credibility when supported by realistic targets for performance measures such as surplus, working capital efficiency (e.g. debtor days, creditor days and stock turnover), asset utilization, tax settlements and dividend projections.

It is vital that management accountants work with treasurers to ensure that plans are ‘bankable’ – that treasurers are confident of being able to secure the liquidity of the organization.

Long-term forecasts are an essential tool for identifying trends and overall cash generation or consumption over time. They are usually driven from plan data prepared by management accountants, and their timescales will typically extend from one year up to three, five or even ten years or more.

In many organizations, cash forecasting is not performed well. The forecasts are often too long, too short, not used or consistently inaccurate. From a practical perspective, the treasurer should monitor their accuracy by comparing actual data to forecasts, and then give constructive feedback to the business units providing the source data.

Key tools for managing liquidity are:

  • Cash management: using cash generated by business operations, cash surpluses retained in the business and short-term liquid investments. The physical day-to-day management of cash ensures that payment obligations can be met
  • Working capital management: managing supplier payments, receivables and inventories to optimize the investment in working capital
  • Organizing and managing borrowing facilities: using cash flow forecasts, building in planned/required new funding and maturing funding that must be repaid or refinanced.

Other tools include managing non-operational items such as capital expenditure, project investment, dividends and disposals.

These tools are all relatively short term, connecting the business with near-term liquidity. In the long term, a business will only thrive if it invests to stay competitive – just compare the performance of Kodak with that of Fujitsu. This stresses the importance of the strategic issues discussed previously. And an organization with little cash can remain liquid as long as it has the ability to borrow.

Tool: Cash Flow Modelling
Cash management

Cash management is part of managing liquidity.

The treasury function is responsible for ensuring that cash flows (receipts and payments) throughout the business are processed as efficiently and securely as possible. Optimizing bank charges and float (the period of time that a transfer is 'in transit') can save considerable amounts of money. One way of doing this is by organizing bank accounts into 'cash concentration' or ‘notional pooling’ structures:

  • Cash concentration (also called ‘zero balancing’) is the consolidating of bank account balances from a number of accounts into one account to offset interest income against expense.
  • While notional pooling has the same resultant offset of interest, the bank instead creates a shadow or ‘notional’ position from all participating accounts; no actual movement of funds is involved.

Table 2: Cash management components

Cash management components

Inter-company payments can often be another source of lost liquidity and inefficiency, due to bank processing time (‘float’), foreign-exchange costs and bank charges. In-house netting systems, providing the ability to offset multiple positions or payments between parties, can significantly reduce these inefficiencies, especially for cross-border transactions.

Another way for organizations to make best use of systems, expertise and economies of scale is to aggregate external payments and collections by outsourcing them. Payment factories, collection factories, in-house banks and shared service centers all use these and other techniques.

Since the global financial crisis, interest rates in many countries have remained relatively low. As a result, the values of cash holdings have been depreciating in real terms, and there is a substantial cost to holding cash. Organizations should regularly review the amount of cash they hold in conjunction with a formal cost/benefit analysis, and adjust the level accordingly.

Working-capital management

Investment in working capital is part of doing business and is a factor in cash forecasting and funding plans. Higher working capital may ensure supply and boost sales and service levels, but at a cost. Lower working capital can reduce an organization’s dependency on borrowing.

Broadly speaking, working capital is inventory and work in progress plus receivables less payables. A business can control it and the cash conversion cycle by adjusting the levels of inventory, supplier payment periods and the speed of collection of cash from customers. It might appear simple for an organization to quickly adjust its working capital to improve its cash position by, for example, delaying payments to suppliers. However, there are a number of risks and concerns associated with adopting this tactic, including the following:

  • It is unethical to unilaterally extend payment terms that have previously been mutually agreed.
  • It is unprofessional, showing up the inability of the management-accounting or treasury function to manage cash on a sustainable basis.
  • It is unsustainable. The cash ‘benefit’ is illusory and transient. Even when overdue debt is eventually settled, the underlying fundamentals will not have been changed by this approach.
  • It is bad for an organization’s reputation, efficiency and effectiveness. Suppliers will respond by increasing prices, levying interest or withholding supplies.
  • It can impact the viability of suppliers, smaller ones in particular.
  • It can impact on the quality of goods or services, as suppliers sacrifice their investment into quality.
  • It adversely affects an organization’s credit standing, making debt financing more costly or harder to find.
  • Suppliers are not banks; they are not in business to provide credit to their customers (or they would charge interest). Credit periods are for their customers’ administrative convenience, giving customer organizations time to process deliveries, execute payment authorization processes and regularize their payments to suppliers.

Getting ahead – The management accountant’s perspective

Management accountants should manage working capital by setting targets for its components. Targets might include:

  • Increasing stock turnover
  • Targeting better supplier pricing and payment terms
  • Setting demanding credit-control targets.

These targets should be reflected in the organization’s cash flow forecasts.

Cash conversion cycles differ from business to business. In a food supermarket, for example, which buys inventory for almost immediate cash sale, cash may flow in before suppliers have been paid. This is a negative cash conversion cycle. In other industries, where inventory is held for some time, organizations may make supplier payments long before they receive cash from sales.

Figure 5: Cash conversion cycle

Cash conversion cycle Tool: Cash Conversion Cycle

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