The 2012 guide to Liquidity Management: SEB - Moving to the next level in liquidity management

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Having centralized liquidity, the next priority for treasurers is to quantify how much liquidity the company actually needs, and how to minimize the costs and risks associated with managing it. By Robert Pehrson, global head of product management (corporate segment), and Patrik Bergström, financial strategy, client relationship management, SEB Merchant Banking.

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Over the past couple of years, treasurers and finance managers have proved very successful in leveraging cash concentration and notional pooling structures to optimize access to liquidity both regionally and globally. In most cases, large multinationals now have solutions in place to enable the efficient concentration of liquidity, cost-effective internal financing and the best use of cash resources. Having centralized liquidity, the next priority for treasurers is to quantify how much liquidity the company actually needs, and how to minimize the costs and risks associated with managing it.

Prioritizing liquidity

There are a variety of reasons why liquidity has become such a significant area of focus, both operationally, making sure that cash is available for use across the business and, strategically, in terms of managing balance sheet and counterparty risk. The first factor is the scarcity of liquidity in the market, particularly for lower-rated companies. This situation has existed since 2008 and with ongoing volatility, a lack of market confidence and tightening regulations, the availability of liquidity is unlikely to increase. Interest spreads have increased, while interest rates are very low, and even negative in some currencies, such as DKK and CHF. In addition, certain types of corporate deposits are less attractive for banks compared with retail deposits, further depressing returns available to corporate investors.

While these factors are all significant in elevating the importance of liquidity management, perhaps the most important issue of all is liquidity risk, which was rarely mentioned five years ago. Volatile markets, such as in the Eurozone, combined with uncertainty over banks’ interpretation of Basel III, mean that treasurers can no longer be complacent about where their funding will come from in the future. This is resulting in corporates seeking alternative forms of funding, such as accessing the markets directly through corporate bond and commercial paper issuance, as opposed to relying on bank funding. In addition, they are increasingly leveraging their financial assets both to fund working capital requirements and manage liquidity risk, such as receivables financing and supply chain financing.

Six steps to strategic liquidity management

Liquidity optimization does not simply involve accessing as much cash as possible, however, it requires a careful assessment of how much liquidity is available, how much is required and therefore how much cash can be invested more strategically. Treasurers need to balance the need to maximize net interest income whilst continuing to support the business in the best way.

1. How much liquidity do we have?
A corporation’s liquidity position comprises more than the cash held in bank accounts, short-term investments and unutilized committed credit facilities. Treasurers need to establish a deep understanding of the company’s cash flows (figure 1) and how these are likely to change over a 12- to 24-month time horizon. They also need to have a clear view of the proportion of this cash that is trapped in entities and accounts in regulated jurisdictions, or as cash collateral tied to long-term credit or derivative agreements.

Figure 1: Key questions in liquidity management 
Source: SEB 

2. How much liquidity do we need?
This is a question that few treasurers have explored in the past, partly as the ‘right’ answer will be different for every company. A corporation needs enough liquidity to cover for the future cash outflows in the form of minimum capital expenditures, working capital at its highest seasonal point, committed dividend payments and short-term debt maturities. Calculating working capital needs should be relatively straightforward by taking a holistic approach to the financial supply chain. Other factors are specific to each industry and each company, such as external rating requirements and targets, cash flow risk and volatility, equity analysts’ view of cash holdings, cash flow risk and volatility, corporate investment strategy and benchmarking with industry companies. Spending time in this area can be highly advantageous, giving treasurers and finance managers greater confidence in the company’s ability to channel cash into strategic business investments that will bring long-term value to the business and enhance competitiveness.

3. How should we hold our liquidity?
As figure 1 illustrates, companies can hold and generate liquidity in different ways: funds from operations; excess cash in bank accounts and financial instruments, and in the form of committed facilities from banking partners. Again, there is no ‘right’ way to hold cash as it will differ by industry and individual company. In making the decision treasurers should balance costs and benefits for holding liquidity. Key areas in this respect include: cash flow dynamics; future potential investment opportunities; liquidity risk (eg, reliability of long-term bank financing); the cost of facilities and interest rates obtainable in the market. Ongoing market volatility also means that this is a question treasurers should revisit regularly.