What is Treasury Liquidity Management?

What makes a business stable? How can leaders measure if their operations are heading in the right direction? Depending on the industry, there might be different metrics, but one thing that remains constant is that as a business owner, and a leader you want to be sure that the company’s financial resources are where they should be. 

In other words, the final goal is to have liquidity. 

That’s where liquidity management becomes important.

But first, let’s go back to the basics.

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What’s Liquidity?

By talking about liquidity, we are talking about how well or not a company is faring concerning its ability to respond to its financial commitments in a short period. 

It's commonly defined as a percentage, a versus between what the business owns and what it owes.

The balance between these two factors is an indicator of the financial position of the business.

It can be used for something as routine as paying the bills or for something more specific like requesting a loan.

What is Treasury Liquidity Management?

Now that we are familiar with what liquidity is, let's take it a step further. Treasury liquidity management is the process that businesses should follow to understand their ability to pay their debts and expenses promptly.

For example, if you want to hire an external consultant for your company, the first thing you must know is: Can you afford it?  

Liquidity management allows you to solve that question.

It works on two spectrums 

It works on two spectrums 

• Positive Working Capital: This means that the company has more assets than liabilities, which has a positive impact on the general financial status.
• Negative Working Capital: This is the opposite, here the company is faced with a situation where its liabilities are higher than its assets. 

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What does the process involve?

Some aspects are considered when evaluating liquidity. 

Forecasting

Just like with any other challenge, you want to be prepared for what’s to come. The same happens with businesses. They need to formulate an idea of any incoming expenses and debts so that they can be fully prepared to cover them without incurring in financial problems. For an e-commerce company, for example, it could be to maximize the profits from a seasonal sale to cover the expenses of the rest of the quarter. 

Asses short-term debts and investments 

Think of them like the yin and yang of your financial health as a company. To keep things on the good side, you have to build an awareness of your obligations and investments. The first, so you can make the payments on time, the latter to be sure that their performance is what you expected. 

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Evaluate the possibility of credit lines

While the word credit might cause a bit of panic, it’s completely normal for businesses to rely on loans to maintain their financial stability if required. This could be because an emergency has happened or something unexpected needs to be solved. 

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Optimize payables and receivables 

This is advice rather than a step, but by having a good understanding of your payables and receivables you can have peace of mind, knowing that both your liabilties and assets are well managed. (link to our blog about this topic) 

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Types of Liquidity

Asset liquidity

This is what we refer to as liquidity in most cases, any asset that can be quickly transformed into cash will be defined as high liquidity. That short-term investment you made with good ROI levels? That’s an excellent asset. 

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Market liquidity

Knowing about market liquidity comes especially handy when you are interested in performing an investment. A market with high liquidity means that there’s the right balance between sellers and buyers and the prices are stable. 

Accounting liquidity 

This type of liquidity offers great insights into the financial situation of a company, as it’s related to the business ability to cover its operational expenses. 

How to Measure Liquidity?

• Current ratio: This metric is useful to know if a company can face its current liabilities with the assets it has at hand right now. It’s obtained by dividing the assets by the liabilities. 
• Quick ratio: It shares some aspects with the previous one, but it differentiates itself by removing from the equation the inventory, given that it might take some time to turn inventory into cash.
• Cash ratio: Obtained by dividing the cash a company has by its liabilities. 

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What is the liquidity risk?

Okay, so if liquidity is the ability a company has to pay for its commitments, what liquidity risk could be? 

If you have said problems, then you're right.

Liquidity risk can happen at any moment when a company finds itself in a situation where paying its debts or expenses is not possible. At least not without provoking financial losses.  The circumstances surrounding liquidity risk can happen from the outside, like a market crisis, or from within, poor financial management.

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What can affect liquidity risk?

Inventory issues

Imagine that your company has more stock than what's needed, you spent money on it and now there's no way to recover it let alone obtain any profit. Now, let's move in the opposite direction. Your inventory is lacking stock so you can't commit to any sales or deliver the product.

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Bad management of payables and receivables 

In case you have forgotten, account payables represent short-term liabilities and account receivables are upcoming assets, like the money a customer owes to your company.

If payables aren't respected, and receivables aren't collected, your company's financial status could suffer.

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Best Practices for Managing Liquidity

Having cash at disposal is a fundamental force for any company, small or large, local or global, the world where businesses operate is driven by money.

So how can you tell if you're managing liquidity correctly?

Monitor financial statements 

These are the reflection of the business's financial health. Just like when you go to the doctor for a check-up, you must understand exactly what’s happening with the company’s money. This way, it becomes easier to take preventative measures if needed.

Automate inventory management

This follows what we said above about the financial issues that overstock or lack of stock can bring to businesses. By going digital, you can be certain about your purchasing decisions, because your inventory is filled according to customer demands.

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Improve payables and receivables processes

Everything boils down to these two, right? But considering they are at the core of every transaction, it’s not a surprise, To make the collection of receivables more efficient you can set up notifications-this in digital software, establish clear conditions from the beginning, and sustain constant communication with customers. For payables, you can discuss payment terms with your suppliers.

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If necessary, cut costs 

Cutting expenses is a phrase that’s a bit unpleasant, but for companies that find themselves already in financial issues, it might be the fastest way to remove unnecessary costs that could be hampering your financial situation. 

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Benefits of Good Liquidity Management 

Better financial health

By developing an awareness of the state of liquidity in companies, short-term commitments can be fulfilled with no financial pain. In the long run, it certainly improves the balance of expenses and profits 

Cash visibility

How can you be sure that your company can afford that new service? That new product? Or that you need to find a solution? Cash visibility brings financial awareness to the table.

Operational efficiency

A good liquidity flow means that the business can, without major efforts, pay for the expenses caused by its operations. Payrolls, maintenance, bills…everything is covered.

Final Thoughts 

So what we have learned today? 

Liquidity management is, indeed, essential for businesses to maintain and promote financial health. Emphasizing proactive strategies, such as cash flow forecasting and optimizing management accounts payables, and receivables with digital solutions sets conditions for steady financial growth.  Why? Because prioritizing liquidity not only safeguards against financial instability but also builds the way for strategic investments and long-term success in an ever-changing landscape.  

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