Liquidity or Cash management
1) Liquidity Management:
"Cash is the lifeblood of a [store], without cash for inventory, payroll, and other expenses, an emergency is imminent." (Cash management, 2009)
Outcalt, R. and Johnson, P.
'LIQUIDITY' OR 'CASH' management is a widely known term used for accumulation, concentration, and disbursement of cash. It comprises of
- Liquidity level of an enterprise,
- Management of cash balances, &
- Short term investment strategies.
All these areas are managed efficiently after forecasting the cash needs of an enterprise to fulfil them. Cash can be pooled internationally and employed effectively through IT and communications systems.
According to Davidson, J.P. and Dean, C.W., cash flow can be a problem even for a small business having numerous clients, offering superior product, and enjoying a sterling reputation in its industry. There is no margin of safety for unanticipated expenses in a cash flow problem facing companies; they experience trouble in funding innovation or expansion & in hiring and retaining good employees. (Cash management, 2009)
The practicability and productivity of liquidity management has improved over time but its general aims remained unchanged. Aims like maximum utilisation of funds irrespective of geography or business structure, to shun the cost of cash shortfalls, the opportunity cost of idle balances that brings sub optimal returns and finally the desire to reduce the management overhead.
Various constraints make accomplishment of aims sub optimal. These constraints emanate from three sources:
- The corporation itself,
- Its financial institutions and banks,
- Lastly, the regulatory/fiscal environment.
Corporation through better management can directly influence first constraint and can do little about the third one it operates in. However, the second category of constraints is in the route of vanishing, thus opening up a whole new world of liquidity management opportunities.
In the past, there is the paucity of international cash management banks that have the reach and depth of services to offer a truly integrated cash and liquidity management proposition at a regional and global basis. Presently, there are large numbers of bank which are providing liquidity management facilities to its users and they are also striving to maximise their potential in controlling cash and its optimised value. 'Once that is in place, new management tools and extensive integrated workflows will be limited only by imagination. Eventually, end to end automation and standardisation become a given, with enhanced analytics simplifying decision making and business rule driven processes extracting the full value from working capital on a real time basis.' (Liquidity Management: A Brave New World, 2009).
2) Sweeping and Pooling:
Cross border sweeping and pooling have been a topic of discussion for many years' among global banks and corporations. Globalization leads companies for operating in multiple markets around the world. Bank accounts multiply as they expand their area of operations and bump into cash positions that vary in different accounts of different countries.
Banks operationalized this opportunity of creating products to tidy up cash balances in multiple accounts & empower companies to offset credit balances of an account with the debit balances of elsewhere. Today, two main techniques available for corporate users are 'pooling' and 'sweeping'. 'Pooling' means offsetting often 'notionally' the different balances so that only the net balance needs to be managed. 'Sweeping' means physically transferring balances from accounts into a single central account. (Global liquidity management comes of age, 2009)
a) Sweeping:
In 'Sweeping' bank transfers funds between the accounts of the company at the end of each day. It is a computerized system which sweeps each sub account in a company's network to smell out surplus funds, & pools them into a master interest bearing account, and vice versa funding the account where there is a cash short fall. Variety of conditions and parameters can be addressed to meet the financial requirements of the business. Moreover, have the facility of transferring funds back to the respective accounts.
Features of Sweeping:
- Sweeping can be set to occur daily on scheduled dates or at periodic frequencies, intra day at specific times and/or on request.
- Sweeps can exercise cleared balance, ledger balance or lowest of two.
- In sweeping, there are facilities such as flexible target, trigger balances and value dated sweeping.
- Enjoying the capability to cope with multiple time zones all over the globe and makes possible global sweeping, either from East to West or from West to East.
- To facilitate multi currency sweeping, exchange rates can be fixed in advance.
- High automation is done to administrate inter company loans & established to use appropriate market rates.
b) Notional Pooling:
Notional pooling is a mechanism of calculating interest on the combined credit and debit balances of the Participating Accounts, without physically transferring funds. Each of your companies will enjoy the benefits of one global liquidity position, without giving up any autonomy regarding their day to day cash management. (Automated liquidity management, 2009)
Features of notional pooling:
- Automatic notional pooling across multiple banks, countries, currencies and time zones, where permitted.
- Cross currency and cross country bonuses where there are restrictions are accorded by netting based on margin instead of interest.
- Offers true multi currency notional pooling rather than converting the accounts via a sweep into same currency then notional pool.
- Interest or margin bonus, and banks' pooling costs are automatically got computed and apportioned.
- Four different methods of interest calculation and five diverse ways of apportioning interest bonus are offered by the system.
- Various costs such as capital adequacy, monetary reserve and funding costs can be compensated by income distribution.
Case study:
'A leading global producer of electrical power cords and cable assemblies uses Lloyds TSB to concentrate its cash in the UK, drawing it from over 100 accounts in banks throughout Europe, the Far East and the Americas. We minimised disruption to the company when introducing a new cash flow management structure by leaving local banking arrangements and account structures in place and focusing on simplifying and improving the company's cash flow management procedures. We provided local working capital facilities in several countries that released cash held as security and enabled the company to sweep it to its central treasury function.
UK accounts with four banks were replaced by a cross currency pool with Lloyds TSB covering US $, euro, sterling, Singapore $ and HK $ funds. The pool comprises bank accounts in the names of three group entities including one registered in Eire. This specialist cross currency pooling facility, primarily used by sophisticated finance departments, has delivered considerable savings for the company, reducing its interest margins by netting off credit and debit balances. Several million pounds more of cash balances are now held centrally which, combined with cross currency pooling, has considerably reduced borrowing costs.' (Managing cash flow through uncertainty – the Lloyds TSB way, 2009)
c) Kinds of Pooling and Sweeping Services:
Managing liquidity is a key challenge for internationally operating businesses. There are various cash management services in various currencies to lend a hand to customers to setup most suitable structures for efficient liquidity management. Cash management structure is designed carefully to meet each customer's specific needs. Various services which are offered are:
- Automated Cross Border Sweeping,
- Automated Domestic (Internal) Sweeping,
- Actual Pooling (Pooling with physical fund movement),
- Notional Pooling (Pooling without physical fund movement),
- Automated Interest Calculation and Allocation,
- Pooling statement reporting etc.
The Corporate Bank relationship
Faced with these problems, corporate treasurers are turning to banks to help them implement cross border cash pools. Indeed, the JP Morgan Global Cash Management Survey 2007 found cash pooling to be the most popular external service used by corporate treasurers worldwide.
And although many banks initially resisted offering more cash management services, two factors have made this area a top priority for banks in 2008:
+ Firstly, banks are experiencing an unprecedented level of pressure to find ways in which to compete for corporate customers' business
+ Secondly, those customers are placing increasing demands on banks to provide greater value and improved customer service
Cash management is now perceived as the number one 'anchor' within the bankto corporate relationship compared to 10 to 15 years ago, when lending was the most important differentiator. Like traditional lending, however, cash management tends to be a loss leader for banks because of the complexity and costs associated with offering this service.
The rise of global cash pooling
Cash is the lifeblood of a corporation and the effective management of cash has long been recognised as a vital ingredient to business success. And to make the best use of their cash, the majority of corporations implement a cash pool. The growth in international trade has prompted the next step: operating cash pools across multiple currencies and countries. Global or regional treasuries are now commonplace and not just in large multinational companies – this trend is also being seen amongst small and mid sized corporations. Cash pooling on an international scale, however, is fraught with problems. The two questions facing corporate treasurers – how much cash is available and how it can be moved to where it's needed? – are much more difficult to answer, with cash spread across multiple legal entities, multiple countries, multiple currencies and probably serviced by multiple banks. In addition, a swathe of regulations and legislation govern the operation of a cross border cash pool.
The opportunity for banks
Banks looking to exploit the corporate cash management opportunity are confronted with a number of significant challenges. Each corporation has unique requirements. It is difficult to obtain detailed information on accounts held on disparate back office systems. Pooling requires complex calculations and processing. And cross border cash pooling is subject to a maze of regulation and legislation. But the ongoing liquidity squeeze just re emphasises the importance of credit and funding for both banks and corporations. Banks that can offer true cross border cash pooling – without incurring high operational costs – will be well positioned to take advantage of one of the few bright spots in corporate banking (McKinsey 2008)
