LIQUIDITY MANAGEMENT SYSTEM

LIQUIDITY MANAGEMENY SYSTEM

Introduction-

The first thing in liquidity management is managing the cash in hand. This basically constitutes of the cash that is usually kept at home for emergency. This comes handy, in case of instant hospitalization, where you have to pay money at the time of admission.

Though the amount kept as cash-in-hand will vary depending upon the number of family members and the expected requirements. However, a minimum of Rs 25,000-30,000 is essential because it is the bare requirement in most situations. This provides an element of safety for the individual. It is very important that this amount is kept away from daily expenses and if used, replenished quickly.

What is Liquidity?

We often hear the word liquidity used in combination with cash management. Liquidity is a firm's ability to pay its short-term debt obligations. In other words, if the firm has adequate liquidity, it can pay its current liabilities such as accounts payable. Usually, accounts payable are debts owe to our suppliers.

There are methods we can use to measure liquidity. Financial ratio analysis will help us determine how liquid firm is or how successful it will be in meeting its short-term debt obligations. The current ratio will help us determine the ratio of current assets to current liabilities. Current assets include cash, accounts receivable, inventory, and occasionally other line items such as marketable securities. We need to have more current assets than current liabilities on our balance sheet at all times.

The quick ratio will allow determining if we can pay your short-term debt obligations, or current liabilities, without having to sell any inventory. It's important for a firm to be able to do this because, if we sell have to sell inventory to pay bills that means we have to find a buyer for that inventory. Finding a buyer is not always easy or possible.

There is various other measure of liquidity that you will want to use to determine our cash position.

When your business is just starting up, we essentially run it out of a check book, which is an example of cash accounting. As long as there is cash in the account, our business is solvent. As business becomes more complex, we will have to adopt financial accounting. However, we have to keep a focus on liquidity and cash management even though our track net income through financial accounting.

Importance of liquidity management-

Regardless of the type of company, effective liquidity management is a core responsibility of its treasury group. Within a financial institution's treasury, it is critical. Core revenue generating functions of banks "capital markets, lending, payments, etc. " depend on sufficient levels of liquidity to operate. Further, as the financial world has become increasingly global, were a bank to have insufficient liquidity to fund a time-sensitive CLS payment or to finance lending activities (think Northern Rock), the ripple effects would be felt across the globe and the reputation of the institution would be seriously, if not irreparably, damaged. With these critical responsibilities, the ability of a financial institution's treasury group to minimize idle balances and identify all cash flows is essential to its success.

Beyond the relationship between liquidity and the revenue generating functions of a financial institution are the costs resulting from inefficient management of it. Manual processes require excess staff, are prone to error and limit treasury's ability to focus on optimizing liquidity and other strategic responsibilities. Further, much of the information required for the liquidity management process exists across multiple, disparate systems, in batch form and is typically not available in real-time. This results in the inability to quickly identify the lowest cost of funds, resulting in increased interest costs. Additionally, these results in the need for treasury to maintain a liquidity "cushion" to ensure liquidity levels do not drop too low.

The Liquidity Management Process -

Effective liquidity management requires three-steps in which treasury identifies, manages and optimizes liquidity. These steps are interdependent, each requiring the successful implementation of the other two to optimally manage liquidity.

Identifying liquidity is the foundation from which the entire liquidity management process depends. It involves understanding the balances and positions of the institution on an enterprise-wide level. This requires the ability to access and gather information across the institution's many lines of business, currencies, accounts and, often, multiple systems. Identifying liquidity is primarily a function of data gathering, and does not include the actual movement or usage of funds.

Managing liquidity within a bank's corporate treasury involves using the identified liquidity to support the bank's revenue generating activities. This may include consolidating funds, managing the release of funds to maximize their use, and tasks that "free up" lower-costing funds for lending or investment purposes to maximize their value to the institution.

Optimizing liquidity is an ongoing process with a focus on maximizing the value of the institution's funds. As the strategic aspect of liquidity management, optimizing liquidity balances requires a strong and detailed understanding of the financial institution's liquidity positions across all currencies, accounts, business lines and counterparties. With this information, the bank's treasury is able to map the strategic aspects of the institution into the liquidity management process.

The biggest challenge in the liquidity management process is the limited time and resources available to treasury. Although treasury groups are staffed with very capable personnel, a large amount of their time is spent on the task-based function of identifying liquidity instead of on the strategic elements necessary to optimize balances. This results in the entire liquidity management process being less efficient and affects the institution's bottom line.

Basic steps for liquidity management-

How companies are implementing steps to improve their liquidity management using these three steps:

1. Improve visibility with centralized payment workflow & approval

2. Reduce costs with electronic execution of payments

3. Reduce fraud and erroneous payments

The economic downturn is affecting how financial institutions manage liquidity in a number of ways. It has particularly affected the liquidity of financial instrument portfolios, which now need to be thoroughly reappraised.

If this is our situation regarding liquidity management-

• Liquidity management procedures are inadequate, and restrictions are obsolete and prevent business from going forward
• The existing level of control over liquidity and cash flows is no longer sufficient
• Additional volume of liquid reserves needs to be attracted to close the liquidity gap
• Liquidity contingency plans are not realistic in the current market conditions
• Fair value and maturity of assets as well as conditional liabilities that could materialize in the current environment need to be identified Quick decision making often fails to follow the even faster economic environment
• The end-of-the-day report, uploaded from the IT system, is always late
• ALM and risk management teams fail to collaborate

How to Maximize Your Cash Flow-

Our goal, as the owner and manager of a company, is to squeeze all the cash out of balance sheet that we can. Not only have we wanted to get as much cash out of our company as we can, to keep it out in case of a potential or actual crisis.

Two of current asset accounts are usually big drains on cash. They are inventory and accounts receivable. Inventory is the products you sell and accounts receivable are our credit accounts or those the accounts that represent the credit extend to customers. The balances in both accounts need to be converted to cash as soon as possible.

We can use financial ratio analysis to check out our position regarding inventory and accounts receivables. Inventory turnover ratios can tell us if our inventory is obsolete or if we are selling so fast our stocking out. Accounts receivable ratios, such as day's sales outstanding, can tell us how fast our credit customers are cleaning up their accounts among other things. Once we determine the position of our inventory and receivables, we can take the appropriate actions to adjust the situations and have more cash coming in to the firm.

Conclusion-

The bottom line to good cash management is that, in a crisis, typical financial statements become irrelevant and all that is important is surviving from a cash point of view. In a cash crisis, such as a recession, a business owner's focus becomes, by necessity, very short-term. Often, a cash crisis will instill good cash management practices into business managers that carry over from that day forward.

References-

• Alexander, Carol et al. :
  • Risk Management and Analysis.
• Bessis, Joel :
  • Risk Management in Banking.
• Brockhaus, Oliver et al. :
  • Equity Derivatives and Market Risk Models.
  • Modeling and Hedging Equity Derivatives.