Best Practices for Managing Liquidity of Your Company

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This article revolves around the best ways in which a company’s liquidity can be dealt with. This includes 1) an introduction, 2) liquidity management techniques overview, and 3) best practices to manage the liquidity of a company.

INTRODUCTION

Liquidity, in simple terms, is the ability to meet financial demands. It ensures that the company maintains equal and adequate cash and liquid assets for mainly two reasons: first, to be able to meet the clients’ demands for loans or savings withdrawals, and second, to be able to pay their own expenses and overheads. Furthermore, liquidity management includes a daily survey and evaluation of the size and timings of the cash inflows and outflows over the coming weeks so that the risk of the savers being unable to access their assets is minimized. It is critical for a business to include liquidity management so that enough information is available in order to make realistic growth and liquidity predictions.

LIQUIDITY MANAGEMENT TECHNIQUES OVERVIEW

Liquidity management techniques typically fall into three main categories. It should be noted that the groups depend on the method used to integrate the balances.

Physical Balance Consolidation

Cash Concentration

Physical balance consolidation includes cash concentration. It describes the movement of funds from participant accounts into a single liquidity position in an account especially created for this purpose. A credit position is moved to the target account, which is usually referred to as “sweeping”, and a debit position is transferred from the target account. Cash concentration is also referred to as zero balancing structure. This includes putting the debit and credit account to zero at the end of each day.

Notional Balance Consolidation

Notional Pooling

The debit and the credit balances are virtually counterbalanced. Due to the debit balance being canceled out by the credit balance, the business can achieve an increased credit interest and supposes a decreased debit interest. Some of the benefits of notional pooling are that it can decrease or even bring intercompany loans to a breakeven. This can lead to the support of decentralized structures.

Interest Enhancement

This is similar to notional pooling, in the manner that does not include physical movement of the funds. The difference is that it applies a set amount of pricing to all the groups of accounts by following set criteria depending on the accumulated net on the balance sheet. This technique requires being able to adhere to the bank and the local regulations regarding the return of an account in the form of an interest.

Hybrids

While it is easy to categorize these methods in theory, in reality it is not as simple. Most of the time, these techniques are merged so that whichever may be more appropriate is used. While sometimes these methods are employed intentionally, most of the times, the hybrid method is taken without even noticing it.

BEST PRACTICES TO MANAGE LIQUIDITY OF A COMPANY

Implementing a Centralized or De-Centralized Model

One may be able to create a centralized or a decentralized business model. The former model will include a business or a corporation having a single cash and flow management solution which the entire business and its departments have to follow. A decentralized model, on the other hand, affords the different departments to make up their cash flow management depending on their own needs. In this case, the workers have the freedom to be more creative, and as more authority is delegated to them, they may show more responsibility.

The question of visibility is also pertinent. If the corporation decides to work as decentralized structure, the regional managers have to bear the burden of collecting and amalgamating the information in a quantifiable data. This is very time-consuming and may also cause confusion amongst the departments.

Improving Cash Forecasting to Enhance Liquidity Management

The business may also work to improve cash forecasting to increase liquidity management. This is critical as these predictions are the basis of the decisions that the managers of the business take. It can impact the entire corporation.

Focusing on Receivables and Payables to Enhance the Cash Position

The company may prioritize on their receivables and payables. By managing the cash flow, the business will automatically have a more focused opinion on their assets and how and in what way to use the assets. It also aids to have some working capital to make the day to day transactions easier and more efficient. The business may also face the problem of trapped cash. The company may have trouble accessing the money in other countries and there may also be problems in managing the liquidity on hand. In the latter situation, the company can develop internal liquidity management departments rather than external which only results in more outflow of money. An advantage of trapped cash is that the business can make an accumulated account of the business from all the departments which will lead to an increased balance of assets.

Best Practices in Cash Concentration

At times when notional pooling is not possible, cash concentration is used in its place. This involves physical movement of the funds from one account to the other. However, it is imperative to know the different types of cash concentration in order to understand the concept better. Various forms of cash concentration include:

  • Zero Balance (ZBA): This is when the balance of zero is attained and maintained by transferring the money from the master account in the exact amount which is enough to cover the present expenses.
  • Target balance: This method ensures that a specific amount is present in each account at all times. This is decided accordingly by the managers beforehand.
  • Threshold: When an account is surplus in cash, one is allowed to move the funds to another account. This results in less confusion and the data is readily quantifiable.
  • Collar: Collar is a direct result of Threshold. When threshold is reached, and the funds are moved accordingly, the balance left is called Collar.

While cash concentration may be more time consuming than notional pooling, it has its set of advantages.

Benefits of Cash Concentration

  1. There should be a fixed set of rules and regulations for the entire business to follow. This allows the employees to have a more concrete idea of what if expected of them. In addition to this, there is a uniformity that is important when accessing and examining the cash inflow and outflow.
  2. As it sometimes happens, notion pooling is an unwanted aspect. This may be because it causes additional bank charges. The interest rate is increased which the business has to pay back.
  3. The cash concentration may also result in legal issues. The law in each country might differ which will lead to confusion of finding a uniformity between the different method of cash concentration that may be used and trying to make sense of it.
  4. The structure of the banking industry can also be better explained and formed accordingly.

The above points result in physically removing the funds in order to enjoy the same benefits.

The Typical Users of Cash Concentration

  1. A business which wants to lessen the reliability of credits in the long run.
  2. A business which has a centralized structure.
  3. A concentrated effort on reducing the result on the balance sheet or tax planning.
  4. Hesitant to delve into the complex arena which includes legal documentation and cross-indemnity provisions to name a few.
  5. An aim to have either a regional or a global consistency in liquidity  management so that variations are decreased to a considerable amount.

Best Practices in Notional Pooling

While notional pooling is used to calculate the combined interest in the credits and the debits, it does not involve the actual movement of funds. It is most suitable for companies who have a decentralized way of managing the business as this allows some control over their subsidiaries and bank controls. It is also sometimes called “interest offset pooling”.

Benefits of Notional Pooling

  1. A notional pooling arrangement allows a certain freedom to the company as it does not have a long-term agreement with the bank. Indeed, it is easy to back out of the agreement if the conditions are no longer suitable for the business.
  2. There is also no bank fees included in notional pooling. This is due to lack of actual movement of funds involved.
  3. There is an increased amount of interest income than possible if investments were made individually in smaller bank accounts.
  4. It also eliminates the hassle of having any overdrafts as cash is stored locally.
  5. It is very convenient for those who partially own subsidiaries. They do not have to be inconvenienced into physically transferring accounts into accounts controlled and owned by someone else.
  6. If global notional pooling is used, it does not require credit and debit balances which may be available in different currencies, to use any foreign exchange rates. This then saves precious time.
  7. There is a decreased amount of interest rate that lessens the company’s expenses.
  8. It can also reduces and in the long run even eliminate the business’s borrowing issues.

The Typical Users for Notional Pooling

  1. A business which is more decentralized in nature and structure.
  2. An eagerness to actually overcome the problems that notional pooling faces.
  3. An open-minded manner and patience to deal with the legalities.
  4. Those who think long term, may be able to overcome these problems so that in the long run, they are able to enjoy the full benefits.
  5. An openness to change. This includes the hybrid nature of both cash concentration and notional pooling so that both these processes combined may result in various liquidity techniques.

Best Practices in Interest Enhancement

In interest enhancement, no physical amount of money is transferred. It is necessary that the total of the balances that are calculated must increase the individual balances of the accounts.

Benefits of Interest Enhancement

  1. This technique is by far the most flexible than either notional pooling or cash concentration. It is also able to work on local and multinational level so that it is very convenient. This is because instead of net balance treatment, it deals with relationship based preferential pricing.
  2. As with any relationships, the dynamics between the bank and the company is constantly changing. In this manner, the prices are determined regarding the relationship the two have. This way, in order to keep track of the relationship, the developments are noted so that the pricing is appropriate.
  3. There is also an increased amount of autonomy and control on the part of the company as opposed to notional pooling and cash concentration. It requires more sophisticated techniques that allow the result to be more reliable and effective. It can also be used a way of finding more improved ways to manage liquidity and its management techniques.

Typical Users of Interest Enhancing

  1. A willingness to develop hybrid structures so that there is more flexibility.
  2. A business which believes in a centralized culture of management.
  3. The requirement of a structure which complements the existing structure of the business.

Best Practices in Hybrid

As mentioned before, hybrid is a mixture of the other types of liquidity management methods. Thus, it carries immense utility and significance.

Advantages of Hybrid

A unique efficiency may be achieved using this method. Both the regulated and unregulated markets can be taken into account in which different techniques have to be used. In this manner the business is able to function in a diversified manner. The use of hybrid structure also enables the confusion and difficulty of liquidity methods to lessen.

Typical users of Hybrid

Most of the businesses use this method as it is more flexible in its management and easier to manage.

In order to manage a company’s liquidity, it is best to know all the types and forms of methods. This enables the company to be able to make the right decision while having all the facts. Notional pooling, cash concentration, and enhanced interest all have their advantages and disadvantages. Businesses have also started using the hybrid method which is an accumulation of all of the three techniques. Liquidity is an extremely relevant and important part of any business, and the managers are suggested to employ these methods by asking for expert opinions.

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