by Liquidity management is one of the most important aspects of corporate finance that ensures a company has sufficient cash flow to meet its short-term operational needs and financing obligations. Effective liquidity management helps businesses avoid cash flow issues that can threaten business continuity. This article explores various tools and techniques involved in corporate liquidity management.
Short Term Funds Planning
One of the key tasks of liquidity management is short term funds planning whereby future cash inflows and outflows for the next weeks or months are estimated. This involves analyzing factors like projected sales, collection of receivables, timing of payments to suppliers and employees, expected capital expenditures etc. to forecast the net cash position. Any possible shortfalls are identified upfront to take proactive actions like arranging additional sources of financing. Effective short term funds planning minimizes uncontrolled cash deficits and ensures smooth functioning of operations.
Accounts Receivables Management
Collection of outstanding customer invoices, also known as accounts receivables, Corporate Liquidity Management is a major source of cash inflow for businesses. As part of liquidity management, firms need to closely monitor the aging of receivables and follow up timely with debtors. Tools like payable discount for early settlement can be used to accelerate collection. At the same time, firms also need credit management practices like evaluating customer creditworthiness, setting appropriate credit limits and payment terms. This balances the objectives of adequate sales with ensuring collections are made as per schedule without increased bad debts.
Accounts Payables Management
Like collections, payment to suppliers is also a major cash outflow. Efficient accounts payable management helps match cash outflows with incoming cash. Tactics used include negotiating payment terms with vendors, taking advantage of early payment discounts and efficiently processing supplier invoices. Maintaining appropriate inventory levels of raw materials further helps control liabilities. centralizing accounts payable can provide economies of scale in payment processing.
Cash Conversion Cycle
Cash conversion cycle (CCC), which represents the time lag between cash expenditures for raw materials and collection from customers, is a critical metric utilized by financial analysts. It encompasses trends in inventory holding period, receivables collection period and payables payment period. Managing these components and accelerating the cash conversion cycle releases locked-up capital for more productive uses or buffer against future shortfalls. Benchmarking the CCC with industry standards also gives useful performance insights.
Cash Budgeting
Effective liquidity management requires preparation of detailed cash budgets projecting inflows and outflows on a weekly or monthly basis for the fiscal period. These budgets aid short-term decision making and helps avoid unexpected shortfalls through proactive actions. Preparation of cash budgets involves data collection from various departments on estimated cash transactions. It essentially connects short term funds planning with operational activities. Regular monitoring and variance analysis of actuals against cash budgets is fundamental to liquidity control.
Cost Effective Financing
To meet funding needs, firms tap multiple short term debt financing options available in the market like issuing commercial paper, availing overdraft facilities or entering into factoring agreements. At the same time, liquidity managers should focus on minimization of financing costs by negotiating competitive rates with lenders, making prepayments to lower interest outflows or choosing between options based on their costs. Optimal utilization of investments like money market funds to generate required returns also conserves cash resources.
