Liquidity Challenges in the US
The attention to liquidity and working capital management has been accentuated by the ongoing impact of the global credit crisis. As a result, one of the biggest challenges that US businesses face is maintaining positive cash flow and liquidity in today’s recessionary, capital constrained environment. While maintaining liquidity and cash are important, it is crucial to have a full understanding of your financial picture to incorporate strategic working capital solutions.
By employing specific cash management strategies focused on optimising cash flow, maximising liquidity, mitigating risk and managing credit more efficiently, a business can maximise its availability of working capital, even in these tough times.
Although technology is a tool that can be used to improve overall efficiency and cut costs, it is not a replacement for a back-to-basics approach to cash management, which is the foundation for an effective working capital strategy.
The first step in developing an effective, working capital strategy is to optimise cash flow as the two go hand-in-hand. According to a 2007 study by the Association for Financial Professionals (AFP), more than two-thirds of the respondents considered cash forecasting to be the greatest challenge to optimising cash and short-term equivalent investments.
Cash forecasting remains a challenge for corporate treasurers at all levels, and the number of treasury operations that continue to use spreadsheet-based programmes as their main forecasting tool remains largely undiminished.
There are two major barriers to effective cash forecasting. First, cash forecasting involves input from many different individuals, causing the models to become unmanageable. Second, basic spreadsheets are not a strong tool for monitoring data input and subsequent amendments to that data. Being able to access timely and accurate information is essential to effective forecasting. Banks and vendors continue to develop online tools to improve cash flow forecasting, which is an evolving process.
Another challenge that may arise is when trying to forecast cash flows that are coming out of multiple-use accounts. Having clearly defined account structures helps to overcome this obstacle. This will enable companies to segregate transactions based on defined criteria and more efficiently match payments to forecasted transactions.
Banks also have an important role in supporting cash forecasting. Although the critical data is typically held by the company within its enterprise resource planning (ERP) systems, banks provide transparency with respect to a company’s payments and receivables data through its expertise and investment in technology. They provide complete disclosure of your company’s finances, which, in turn, allows you to make sound decisions with a complete financial picture. Banks also play a role in consolidating data and presenting it to the corporate treasurer in a way that is consistent, timely and of value. Working with your banking partner to implement cash forecasting can help you optimise cash flow.
Liquidity solutions also present opportunities for businesses to maximise cash flow. While there may not be an end-all solution to the liquidity challenges that businesses are currently facing, there are ways in which these challenges can be overcome or at the very least, effectively managed.
The collapse of the auction-rate securities market forced treasurers to seek out conservative, low-risk investment vehicles. When that market seized up after the collapse of Lehman Brothers, and dealer support did not materialise, losses were incurred, or funds were set aside to cover those expected losses. This created a need for businesses to seek alternative liquidity solutions.
The future is unknown; yet, non-US cash growth is projected to grow at a greater rate than US cash. Thus, if US corporate treasurers are planning on holding cash going forward, they should consider holding more non-US cash.
The AFP liquidity surveys conducted over the last several years reveal some significant findings. First, companies with more than US$1bn in annual revenue are decreasing investments in all short-term instruments other than money market mutual funds and eurodollar deposits. Otherwise, their short-term investment policies are restricting the overall access to other instruments.
On the other hand, companies with annual revenues less than US$1bn have already moved their funds into safer investments. These companies took a more diversified approach to short-term investments. The expectation is that the short-term investment funds will continue to be invested in money market mutual funds and bank deposits.
In a time of turbulence, it is a return to the tried-and-true basics of cash management that are fundamental to success. Effective investment management requires balancing the fundamental principles of liquidity, return safety and security. By implementing processes and procedures tailored to specific needs, banks can help businesses weather this storm.
In this global credit crisis, there are heightened concerns around risk and security for businesses. Treasury must ensure that there are adequate controls and processes to address not only fraud, but financial and accounting risk, given the heightened regulatory oversight around financial management. Moreover, companies need to rely more and more on business partners globally, without increasing risk.
It is imperative for your business to incorporate specific tactics to help mitigate risk. These include using internal controls, such as account protection and daily reconciliation, and using technology, including the electronification of payments, web-based reporting and two-factor authentication. The imposition of these controls, coupled with additional reporting requirements, drive automation and standardisation of treasury processes. The next logical steps in optimising the efficiency of working capital and improving transparency are the integration of trade with liquidity and risk management, and then to create standardisation for increased efficiency, visibility and control.
Managing credit efficiently is a cornerstone of your company’s working capital strategy. If you are electing to use credit as a part of your financial strategy during this time, then it is crucial to maintain a strong balance sheet, which can help improve your organisation’s access to credit. Balance sheet analysis will be a key component in a bank’s evaluation of the sustainability of your business.
Operating cash has to sit somewhere and your deposits are highly valued by banks right now. Because banks are under tight scrutiny and need to shore up their financial reserves, they value the deposits they receive from corporations in the form of operating capital or dollars that are waiting to fund other projects. If you need to borrow capital, you should explore with your lender how your deposits factor into the negotiation. For companies with excellent credit, deposits could tip the scale in your favour for obtaining capital. Understand that your money market deposits may be the key to the operating capital that you need.
In addition, employing the previously mentioned cash flow forecasting tools will strengthen your credit position and the ability to secure working capital loans. Lenders view well-tailored, efficiently administered cash management processes as being indicative of a stable, capably managed organisation with lower risk levels.
There may not be one end-all-be-all solution to the liquidity challenges that the US and globally, however, it is important to be cognizant to the fact that by working with your banking partner to implement the tried-and-true basics of cash management, cash forecasting and working capital solutions, liquidity is attainable.