Treasury Risk Management

Core Requirements for Effective Liquidity Risk Management

By James Grefalde

“Liquidity risk management is essential for the success of any business."

Poll

If sufficient liquidity is available at the right time, a company can make investments, achieve its goals and - most crucially - survive in any crisis”

• True

• False

• Maybe

• Sometimes

This is precisely the sort of situation which highlights the importance of having good visibility of changes in liquidity at all times.

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Liquidity risk management: the requirements

Liquidity risk management relies on having a regular overview of balances on all available bank accounts and liquidity risk sources, such as loans, lines of credit and investments. This includes receiving a balance report on a daily basis showing the change in these positions over a short time period.

But what if decisions need to be made today for a period in the future?

In this case, liquidity planning is essential for companies. It provides a structured view of key incoming and outgoing cash flows at the company based on the operating assumptions for a fiscal year. 

if significant changes become apparent over time, the plan is modified. Where such changes are made, this is referred to as rolling planning, which enables new insights and their impact on liquidity to be accounted for and developments over the year to be anticipated.

Annual and rolling plans are compared and differences analyzed with the aim of reliably controlling liquidity for the company.

Why is it so important to keep an eye on this information at all times rather than when the company’s financial situation starts to deteriorate? 

​The role of management in liquidity risk management

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​One of the duties of a managing director is to keep a constant eye not only on the financial growth of the company but also on its solvency. A daily financial status overview combined with a structured liquidity plan provides an excellent foundation in this respect, forming a reliable basis for every strategic decision. 

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​Evidence for lenders and shareholders

Liquidity planning is a necessary prerequisite for any financing. Financing providers and investors do not just want to know what kind of return they can expect on their investment; they also want to be reassured that they will be repaid over time. 

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​Evidence for lenders and shareholders

Evidence of this must be presented before a decision is made and can be provided by liquidity planning. A plan that can be reviewed and reinforced on a rolling basis has a lasting positive impact on the reputation of a company in the eyes of all stakeholders.

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​Liquidity risk management: key considerations

Companies must set out standards to ensure the requirements mentioned above are met: all participating companies should prepare plans according to set procedures, regardless of whether they are involved in production or sales.

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​Liquidity risk management: key considerations

All units involved in planning need a common exchange rate basis if they operate in different countries and all should follow the same process for planning.

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Challenges: Establishing structures

Entities use their own exchange rate scenarios and convert all planning values to their local currency. Plans are only partially completed or certain information provided is contradictory. Units and formats are changed and used differently. There is no coordination between operationally linked units, and so on. If instructions are too complex or requirements too onerous, entities are often overwhelmed and use the information incorrectly.

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Challenges: Pulling together company-wide data

If instructions are not fully adhered to and information is delivered in various ways, pulling together a plan at group level is a tedious exercise. Data must be transferred manually, assumptions scrutinized, currencies summed and formats changed. A high degree of commitment is required to adhere to specified time frames and avoid data being superseded in the meantime by more recent data. Manual entries are prone to errors and delays are often anticipated and built into the schedule.

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The solution to liquidity risk management’s riddle

In our digital, globalized world, using software is the obvious answer to increasing efficiency and improving the underlying data. Ideally, companies use a group-wide system to which all relevant employees have access and which thus provides reliable data in real time. Having sufficient liquidity is crucial. Having a system support you with this task is invaluable.

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