Managing Liquidity and Optimising Working Capital - Essay Example

MANAGING LIQUIDITY AND OPTIMISING WORKING CAPITAL] Since the Great Depression, the 2008/09 financial crisis proves to be the worst financial crisis. The 2008 financial crisis resulted into global economic meltdown due to the collapse of large financial institutions, the Federal Reserve Board (Fed) bailouts of banks and collateral damage to the stock market (Reuters, 2009). The adverse consequences of the crisis have triggered regulators and central banks to introduce various measures and reforms to enhance stability of the global financial system and protect taxpayers from the fallout of any future crisis. Majority of the banking sector targeting, regulatory reforms, have a central goal of improving stability and restoring investor confidence. The impact of regulatory reforms brings significant complexity for banks. In particular, the reconciliation of bank’s capabilities with regulatory restructuring potentially limits the ability of banks to provide solutions to their clients. Incompatible regulations or incompatible implementation of regulations could, therefore, create risks that damage companies’ ability to operate profitably. In a treasury management perspective, tax regulations affects the notional pooling structure and traps liquidity by limiting flows and cross border sweeps between head office and their subsidiaries. Other developments that are limiting the ability of banks to serve their customers include requests by regulators for international bank branches in foreign countries to become subsidiaries. For example, the proposed FBO rule introduced in December 2012 by the Fed for treatment of foreign banks and foreign non-bank financial companies in the US would require the establishment of an intermediate holding company (IHC) to hold all group subsidiaries in the US (Guynn, Lee, & Kini, 2013, p. 5). This has the potential of eroding the global risk diversification benefits by trapping liquidity and capital, and may achieve the opposite to the stated objective of a global resolution approach for financial institutions. Treasury and finance evolution in the next decade stems from the impact of global realignment and digitisation with Asia as a major driver. The rise of its export manufacturing sector and its emerging market consumers has driven companies to rethink their global strategies. The shift in geographical distribution of cash flows has made optimising liquidity a challenge because of regulatory and tax constraints and in turn, reshaping the boundaries, cost structures and competitive position of businesses across the region. Ensuring that a company have sufficient cash in the right currency at the right time is critical and any unfortunate discrepancy can result in a company facing unnecessary working capital funding needs. Additionally, the inability to use liquidity effectively results in trapped cash similar to having an asset that is below its potential use. As a result, the under-utilised asset becomes a burden on the balance sheet of a company. Market volatility such as the slump in the Indian rupee in 2013 or potential widening fluctuations against the RMB with China’s central bank loosening daily trading limits in March 2014 can significantly impact corporate earnings, if it is not managed appropriately. An important component of treasury is to benefit from favourable market moves while protecting their company from adverse market fluctuations and falling below the margin. Hence, when regulatory restrictions affect the convertibility and offshore movement of funds, companies strategically invest their cash locally as to retain value until repatriation. To enhance visibility and control in the best interest of the company, a structural approach involves companies to extend their trade payables and shorten trade receivables terms. Since corporate treasurers and banks’ treasurers are the main players that are involved in optimisation of working capital and management of liquidity, they face various challenges in creating and supporting strategic transactions, especially in the global arena. In this essay, the impact that managing liquidity and optimising of working capital have on corporate treasurers is investigated. The essay also analyses how banks’ treasurers can support strategic transactions. There are various effects that the role of a corporate treasurer is currently facing given that liquidity has gained preference over earnings growth to creditors and investors. This is because corporate treasurers have found themselves in a situation where they have to focus more on working capital to maintain liquidity than the growth of earnings (Beard, 2014). On the other hand, banks have been retooling and shrinking their balance sheets to fund themselves internally (Beard, 2014). This is because traditional sources of funding have become scarce and more expensive than before. This creates the necessity of improving the working capital efficiency of a company so that the company can be able to finance its operations internally, if outside sources of finance prove hard to access. Investors are willing to invest in companies with high cash-to-asset ratios, where they are assured of obtaining value for their investment. As a result, corporate treasurers have decided to maintain high cash-to-asset ratios, in their efforts to optimise working capital (Beard, 2014). Consequently, such companies have been able to create a better position for themselves such that they are flexible and they can always be better off financially when access to alternative funding is unavailable or inaccessible. However, treasurers face some pressures in maintaining a company’s liquidity because more focus on payments efficiency does not address supply chain risks, which might have an effect on wholesome liquidity implications. Also, pricing strategy changes that corporate treasures may employ in a bid to manage liquidity may affect foreign exchange risk and liquidity (Beard, 2014). Corporate treasurers have been charged with a larger responsibility of maintaining heightened vigilance so as to safeguard the financial well being of their companies. For instance, under the new approach of maintaining and optimising working capital, corporate treasurers have to review contingency procedures for both their own company and those of the financial provider. This means that corporate treasurers have been forced by circumstances to be persistent in seeking to achieve a positive impact on Economic Value Added (Havoutis, 2002). Given the current changes in global market and financial trend, corporate treasurers have to employ the most modern liquidity and investment management concepts that are offered by financial firms. Due to the need of liquidity management and working capital optimisation, corporate treasurers have to find out how to create a cash management method that creates mutual relationships with both debtors and creditors (Camerinelli, 2010). For instance, to increase high liquidity, a company has to increase its accounts payables and decrease its accounts receivables. This means that such a company may have to make late payments to its suppliers or leave inventory within the suppliers’ premises until the inventory is required for the production process by the company. Consequently, letting suppliers to keep inventory for the company will increase costs for them while delivering late payments may harm the confidence that suppliers have for the company (Camerinelli, 2010). On the other hand, reduction of a company’s accounts receivables implies that customers will be made to pay within a very short period of time, which might scare them away. Therefore, corporate treasurers are under pressure to formulate integrative strategies that strike a balance in managing the company’s accounts receivables and accounts payables without creating adverse effects on the company’s performance, while seeking to optimise working capital or managing liquidity. Corporate treasurers have to put themselves into greater task than before and perform a crucial role in improving a company’s bottom line (Deutsche Bank, 2012, p. 3). The need to manage liquidity and optimise working capital has put them under pressure to achieve numerous objectives, using minimal resources (Deutsche Bank, 2012, p. 3). In addition, corporate treasurers are supposed to be able to manage cash flows, even in situations of volatile exotic currencies, while creating good relationships with banks (Price Waterhouse Coopers, 2009, p. 2). In light of the need to optimise working capital and manage liquidity, corporate treasurers are required to guard the flow of cash through their companies’ financial value chain (Pozin, 2008, p. 1). Banks’ treasurers have a duty to perform as far as assistance for companies to optimise working capital and manage liquidity is required. For instance, banks’ treasurers may aid in supporting strategic transactions by developing insights, which will enable banks to meet their client companies’ individual needs (Bank of America, 2014). Secondly, banks, through their treasurers, help companies to collect cash from clients, make appropriate investments and make payments to their creditors and suppliers. They also provide assistance in the financial supply chain, through the processes of procurement of inventory and payment to suppliers, making orders for owed cash from debtors or clients and managing cash (Beard, 2014). This means that banks’ treasurers accelerate the cycle of cash conversion, which in turn, enhances or optimises working capital and contributes to effective management of liquidity (Beard, 2014). Majority of the banks are taking various measures to assist companies to manage liquidity and optimise working capital. For instance, various banks seek to aid in cash forecasting by creating and implementing online tools, which can be used by companies to make improvements in cash flow forecasting (Graves, 2009, p. 1). Banks’ treasurers also provide full information pertaining to a company’s finances. This contributes to strategic transactions because it provides companies with a complete financial picture, giving them an opportunity to make informed. Also, banks; treasurers consolidate data and present it to corporate treasurers in the best form that can be used to make strategic transactions and in time (Graves, 2009, p. 1). Banks’ treasurers play a role in ensuring that their client companies have appropriate contingency procedures (Havoutis, 2002). Additionally, through the provision of real time and relevant transaction data, banks’ treasurers contribute to accurate cash flow forecasting, hence strategic transactions. Therefore, companies have a chance to find appropriate funding and liquidity risk assessments (Deutsche Bank, 2012, p. 7). Banks contribute to strategic transactions by offering electronic distribution services, which enable company treasurers to obtain information on liquidity management, foreign exchange and cash flow planning. This is because companies get to know various regions’ liquidity positions so as to improve cash forecasting accuracy (Deutsche Bank, 2012, p.7). Finally, it should be noted that banks support companies through the development and delivery of superior service products (Pozin, 2008, p. 1). In conclusion, it should be noted that the 2008/09 financial crisis contributed to the current development, whereby companies seek to optimise their working capital so as to be able to fund their operations internally, in case they fail to access external funding. Adoption of this trend of liquidity management has put corporate treasurers under pressure because they are required to strike a balance between various stakeholders and optimise working capital, using limited resources. Given that some of the goals are conflicting, corporate treasurers are required to formulate integrative strategies. However, banks’ treasurers have come into the aid of corporate treasurers in various ways. For instance, banks’ treasurers provide real time and relevant transaction data and help in the timely collection of cash from clients, choice of appropriate investments and making of payments to creditors and suppliers, as well as, providing of information pertaining to various regions’ liquidity positions. This improves accuracy in forecasting of cash flows and execution of strategic transactions. References Bank of America., 2014. The Evolution of Relationship Banking. Treasury Management International, pp. 1-3. Beard, M., 2014. The New Liquidity Paradigm: Focus on Working Capital. [Online] Available at: [Accessed 28 March 2014]. Camerinelli, E., 2010. Working Capital Optimisation: Risky Business. [Online] Available at: [Accessed 28 March 2014]. Deutsche Bank., 2012. Optimizing Liquidity Management: Increasing Transparency and Efficiency to make Company Cash Work Harder. White Paper, pp. 1-8. Graves, J. (2009, March 31). Liquidity Challenges in the US . [Online] Available at: [Accessed 28 March 2014]. Guynn, R. D., Lee, P. L., & Kini, S. M., 2013. Regulation of Foreign Banks and Affiliates in the United States: Seventh Edition. St. Paul: Thomson Reuters Westlaw Press. Havoutis, N., 2002. Defining the Times: Concepts for Advanced Liquidity Management. [Online] Available at: [Accessed 28 March 2014]. Pozin, C., 2008. Liquidity Management - Plotting Progress in a Turbulent Market. Treasury Management International, pp. 1-4. Price Waterhouse Coopers., 2009. Understanding the Corporate Treasurer: Banks need to put Themselves in their Customers Shoes. [Online] Available at: [Accessed 28 March 2014]. Reuters., 2009, February 27. Three Top Economists Agree 2009 Worst Financial Crisis Since Great Depression; Risks Increase if Right Steps are Not Taken. [Online] Available at: [Accessed 28 March 2014]. Read More