How does liquidity management work and why is it so important?

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Liquidity management is an important task of a company's treasury department.

Liquidity management is one of the main pillars of a company's financial management, because it ensures solvency. Here we show you why it is so important for companies, how it works in principle and how companies can implement it in practice.

Liquidity management in treasury: Why is it important?

Liquidity management is an important task of a company's treasury department. The main task is to ensure the liquidity of the company at all times and to make sure that there is always enough money available to pay the company's bills and make investments.

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Sound liquidity management is characterised by the following features:

  • Absolute transparency and overview of all incoming and outgoing cash flows
  • Constant overview of receivables and liabilities
  • Accurate and detailed liquidity planning for the coming months, taking into account the current and expected business development
  • Dynamic planning: Regular updating of plans and drawing target-performance comparisons

Liquidity management: Objective

As mentioned above, the main objective of liquidity management is to ensure the company's liquidity at all times and to raise the necessary funds to finance the day-to-day business.

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However, the treasurer must not forget that the company also wants to increase its turnover. The goal of increasing turnover is, however, contrary to securing liquidity, because in order to increase turnover, investments must be made for which cash is necessary.

Agreeing on these two opposing goals is therefore also part of the treasurer's task when planning liquidity. He must look at the investment plans as well as the strategic goals of the company and then develop a strategy of how sufficient cash can be made available for these on the one hand and how the solvency of the company can be ensured on the other.

Liquidity management: Example

A company wants to expand its production capacities in the near future because it is foreseeable that demand for its products will increase. Those responsible want to use both equity and debt capital for the investment, whereby the main part is to be financed from equity and the bank loan is to be kept low.

The managers sit down with the treasurer, who presents them with an up-to-date liquidity plan for the next six months. This takes into account how income will develop upwards due to increasing customer demand. This also increases the surpluses each month, part of which can be set aside for investment.

Based on these figures, instead of making the investment immediately, those responsible decide to wait another five months so that more equity is available for financing.

Liquidity management: Types & techniques explained

Liquidity management consists of two steps that require different techniques to achieve their objectives. The first step is to get an overview of the current and past cash flow; the second step is to design a plan for the expected future cash flow.

Cash flow monitoring

Continuous monitoring of cash flow is the basic prerequisite for reliable liquidity management. The more closely you can monitor the cash flow, the better. Optimally, you can see the current cash flow in real time, i.e. you can see at any time what income and expenditure is taking place in the company's accounts.

If you also create an overview of past cash flows, you can also see what the company regularly spends money on (e.g. recurring expenses such as salary payments and general operating costs). This enables effective cost control and gives a deeper insight into the company's cash situation.

Cash flow planning

In the second step, the past and current cash flow data are further developed and a plan is created for the coming weeks and months. Recurring disbursements can easily be included in the planning, while estimated values are entered for other expenses and income.

In order for the estimates to best reflect reality, it is important to reflect the business development as realistically as possible. To do this, it is often necessary to liaise with sales and other departments so that realistic values for future revenues can be derived from customer and market analyses.

If investments are planned, these must also be included in the planning, i.e. when the investment will be made, when you will receive a loan and how high the loan instalments are that you have to pay back each month.

Once you have recorded all these processes in the liquidity planning, you can see exactly how much cash you have available every week or every month, whether a cash shortage is occurring, and whether the business objectives can be achieved at all on this cash basis.

How to manage liquidity

In the previous section we explained the basic approach to liquidity management. You can already see that for a detailed cash flow planning, data from many different sources are necessary and a lot of data has to be collected.

The majority of companies use Excel for liquidity management, whereby the account transactions are manually entered into a table. The disadvantage of this method is that it takes a lot of time, is prone to errors and the cash flow in the table is never up-to-date because the cash flows change every day.

In addition, there is no time to update the spreadsheet every day, which is why companies usually work with outdated data and make important decisions based on it. The lack of an overview can often lead to suboptimal decisions.

Dedicated liquidity management tools

To overcome the disadvantages of the Excel method, there are now dedicated liquidity management tools on the market that can display the cash flow in real time. These tools connect to the company's bank accounts, automatically retrieve the transactions from there and update the cash flow planning based on this latest data.

This offers companies several advantages: Employees no longer have to spend valuable time entering figures in Excel spreadsheets and those responsible can look at an up-to-date cash flow and liquidity planning every day.

In liquidity management tools such as Agicap, any number of secondary plans can be created based on the main plan, in which those responsible can look at different scenarios: What happens if customer demand drops sharply? How long will our cash reserves last? Is it less risky to take out a bank loan for an investment than to tap into our reserves? Using such a tool for liquidity management makes it easier to make important decisions, as you have a reliable database that is always up-to-date and does not require any manual effort.

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