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The art of managing cash

The art of managing cash is to help businesses gain greater control and visibility over their money, such as through bank rationalisation, forecasting, or investment policies.

Liquidity management is a core activity undertaken by a company’s finance or treasury team. The primary aim of liquidity management is to ensure that the company has sufficient liquidity (right place, right time, right currency) to meet the financial obligations of the business, including paying employees, reimbursing suppliers for goods and services; repaying debt; and making investments.

Companies with robust liquidity management can respond quickly to changing market conditions, generate more resilient and lower cost sources of funding and get optimal yield on their surplus cash. Companies with poor liquidity management may have to pay more to borrow externally, struggle to meet all their obligations and suffer reputational damage, and, in a worst-case scenario, fail to keep trading. It is not surprising that rating agencies have become more aware of the impact of good liquidity management and often consider this as part of their assessment.

Every company is unique in terms of the complexity of its business; the regulations it must comply with; and the currencies, geographies and time zones in which it operates. An effective liquidity management strategy takes these unique considerations into account and is based on a deep and detailed understanding of the particular circumstances.

  • Account structures

    Having control and visibility over bank accounts is the natural starting point for good liquidity management. Unfortunately, many companies lack this control and visibility because they do not have streamlined banking relationships. They may have grown over time via acquisition and steadily taken on new bank accounts as a result. Many will have multiple banking relationships in multiple jurisdictions, which can make it difficult for them to gain visibility over their data. Meanwhile, the overall account structure of the organisation may no longer meet its requirements.

    Often it is necessary for a business to undertake a bank rationalisation process in order to gain full control and visibility over its accounts. This process should reflect the nature of the organisation, its structure and its goals. For example, different approaches are required to manage liquidity in a decentralised organisation compared with one that is highly centralised. In a decentralised organisation, the individual entities may still need to have their own bank accounts so that they can run their operations effectively.

    In a more centralised organisation, the favoured approach might be to hold the majority of cash at the centre. In reality, for most businesses, the solution is often hybrid – with entities retaining control over some cash and the remainder being managed at the centre. It is common also for companies to centralise payables processes, while leaving receivables decentralised. The challenges of centralising receivables makes this understandable but it does lead to surplus funds in one location and deficits in another. Without efficient liquidity solutions to remedy this, increased costs and operational risk are inevitable.

  • Cash pools

    Cash pooling underpins robust liquidity management. With cash pooling, several related bank accounts are connected together in a structure that enables the aggregation of their balances. In this way, the Corporate Treasury has maximum control and visibility over its liquidity, and can maximise returns on its surplus cash, while letting individual entities within the group have varying degrees of financial independence.

    • Physical pooling – where excess cash in related bank accounts is physically swept into the primary bank account. This type of structure is often used where payables are managed centrally but receivables are managed locally and ensures that sources and users of funds are brought together. Tracking and arm’s length interest arrangements on the resulting intercompany positions ensures tax and accounting integrity. 
    • Notional pooling – where the cash in the related accounts is notionally offset against the primary account with no physical movement occurring. Notional pooling can be an effective way to consolidate cash in a decentralised organisation. While the individual accounts are often controlled by the entities themselves, the treasurer is able to manage the net position of the pool, which is used by the bank for the purposes of calculating interest on the overall pool. Notional pooling solutions also enable interest conditions to be set by the Corporate Treasury for the underlying entity accounts 
    • Hybrid of physical and notional pooling. In practice, many pooling structures tend to be hybrid structures since some activities are easier to centralise than others. Local receivables accounts may be concentrated into a header account in country in the name of the finance vehicle and then swept into a notional pool. 
    • Virtual accounts. Virtual accounts are another increasingly popular option that enables flexible, yet efficient, liquidity management. In terms of structure, virtual accounts are a set of internal transactional accounts that are linked to a single physical bank account.
  • Forecasting

    Cash flow forecasting is essential to good liquidity management. Forecasting enables the treasurer to predict when payments will need to be made, and when receipts will arrive, so that liquidity can be managed appropriately. This is obviously easier for some businesses and sectors than others. For forecasting to be effective, the treasurer needs to understand the end-to-end working capital cycle of the business. Businesses that actively manage their working capital cycles go one step further and actually control their payables and receivables cycles to optimise liquidity.

  • Investment policies

    An investment policy is vital to manage the risks associated with liquidity management. This policy should consider concentration risk (the risk that too much money is concentrated with one counterparty), counterparty risk (the credit risk that the institution will not fulfil its obligations, with duration being a related consideration and market risk (the risk that an investment loses money due to fluctuations in the market).

  • Security, liquidity or yield?

    Naturally, companies want their surplus cash to generate extra income for them, but they need to balance this desire for yield with security of investment and their own liquidity requirements. Continuing market and geopolitical uncertainty mean that while yield is important – especially for businesses that operate with fine margins– it tends to be less of a priority than security and liquidity.

  • Summary

    Businesses tend to be highly focused on bringing in cash but it is very important to manage the resulting positions on an ongoing basis and also to conduct regular reviews. Effective liquidity management, undertaken in conjunction with proper working capital management, is crucial to ensuring that a business can continue to operate, is unlikely to suffer from negative surprises, and benefits from optimal investment returns.

    Barclays can help you to create a more effective liquidity management strategy for your business. To find out more, speak to your Relationship Director.

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