The guide to liquidity management for CFOs and treasurers

Liquidity management is the strategic process of ensuring a company maintains sufficient cash flow to meet its current obligations while optimizing the use of its financial resources. Ultimately, the goal is to have sufficient funds to cover operational expenses and short-term debts while avoiding the opportunity cost of holding excess idle cash.

At its core, effective liquidity management relies on accurate cash flow forecasting. This involves predicting future cash inflows and outflows based on factors like sales projections, payment terms, seasonality, and market conditions. To achieve this, CFOs and treasurers employ a range of forecasting methods, from simple historical trend analysis to sophisticated statistical models and scenario planning tools.

For instance, a retailer might couple historical December sales data with consumer confidence index (CCI) trends during the holiday season. Meanwhile, a manufacturing firm might leverage its production schedule and supplier payment terms to project cash needs for the coming quarters.

It's important to note that liquidity management extends beyond just cash. It encompasses all assets that can be quickly converted to cash without significant loss of value. This includes convertible near-cash assets like marketable securities, short-term investments, and, for some businesses, inventory.

Liquidity management is the linchpin of financial stability — the safety net that catches your company when market winds shift unexpectedly. It’s also the springboard that enables CFOs and treasurers to pounce when growth opportunities arise.

A sound liquidity management strategy helps businesses anticipate and prevent cash flow shortages. By maintaining a clear picture of incoming and outgoing cash flows, companies can ensure timely payments to employees, key suppliers, and creditors. Without this foresight, even profitable companies can find themselves in a cash crunch, potentially damaging professional relationships and disrupting day-to-day operations.On the flip side, consistent, on-time payments can significantly strengthen relationships with vendors and lenders. This can lead to more favorable credit terms and better access to financing opportunities, directly impacting a company's profitability. For instance, a company with a strong track record of prompt payments might negotiate extended payment terms with suppliers or secure lower interest rates on loans, freeing up cash for other strategic initiatives.

A company with strong liquidity can also capitalize on unique, unexpected business opportunities. Let’s say your No. 1 competitor suddenly files for bankruptcy. With enough cash on hand, you’ll have a chance to acquire their assets at a discount and gain a significant competitive advantage.

Corporate liquidity management is especially crucial during economic downturns. Companies with healthy cash positions and well-managed liquidity are better equipped to weather market turbulence. They can continue to invest in critical areas of the business, such as R&D or talent retention, even as competitors may be forced to cut back.

Take Apple, for example. The tech giant is renowned for its substantial cash reserves, which have allowed it to navigate economic uncertainties while continuing to invest in innovation and strategic acquisitions. During the 2008 financial crisis, while many companies were struggling to stay afloat, Apple's strong liquidity position enabled then-record investments in R&D, eventually leading to the launch of groundbreaking products like the iPad.

The big takeaway: Effective liquidity management is not just about surviving; it's about thriving for years to come.

Both external and internal factors can significantly impact your company's liquidity position. Staying cognizant of these potential pitfalls is the first step in safeguarding your organization's financial health.

External factors

External factors are difficult to predict and control and can impact your liquidity position with little warning. Market conditions, for instance, can fluctuate rapidly, causing sudden decreases in demand for products or services. An increase in competition can lead to price wars and slash profit margins. Global economic downturns also have far-reaching effects, impacting overall market activity and consumer spending. Beyond market-driven challenges, companies must also contend with unexpected events that can pose significant liquidity risks. Natural disasters can disrupt supply chains and operations, while political instability might cause capital flight and market volatility. The same goes for global pandemics and global health crises.

Consider the case of Flybe, which once ranked as Europe’s largest independent airline. The COVID-19 pandemic hit the airline industry hard, but Flybe was completely wiped out after years of poor liquidity.

With insufficient liquidity to withstand rising fuel costs and the decline of the pound, Flybe was forced to ground its planes in 2019 and sell to Connect Airways. Later rebranded Virgin Connect, the airline was on the verge of receiving a ~£100m rescue loan from the UK government in February 2020. But, when air travel was halted indefinitely, the loan was called off.

No one could have predicted the price of crude oil years in advance, let alone the global pandemic. Still, the airlines that had stronger liquidity management processes in place were better positioned to withstand these events.

Internal factors

Liquidity issues are often triggered by suboptimal cash flow management. Inefficient collection of receivables, excessive inventory levels tying up funds, and unforeseen expenses can all leave companies cash-strapped.

Sneaker giant Nike was hit particularly hard with excess inventory post-pandemic. Inventory issues and a host of other factors tanked its stock price and led to Nike’s longest losing streak in four decades.

Overdependence on short-term financing can also create liquidity risk when companies can’t renew lines of credit during economic stress. Or when rising interest rates increase borrowing costs.

Unexpected liabilities — lawsuits, regulatory fines, new tax laws, and sudden changes in compliance requirements — can also jeopardize liquidity.

Iconic toy retailer Toys "R" Us filed for bankruptcy in 2017 due to a confluence of external and internal factors.

Toys "R" Us lost significant market share to Amazon and big-box retailers like Walmart. Arguably too slow to downsize and adapt to the changing landscape, they filed for Chapter 11 with over $5 billion in long-term debt.

Despite generating billions in revenue, Toys "R" Us struggled with liquidity due to high interest payments and the inability to invest in necessary operational improvements.

You never know what tomorrow will bring, but a strong liquidity management strategy can help you brace for the unknown. This involves not only preparing for known risks but also building flexibility into financial plans to handle unforeseen challenges.

Effective corporate liquidity management requires a proactive approach with constant monitoring of both the business environment and internal operations to identify and mitigate potential liquidity risks — before they escalate into crises.

CFOs and treasurers need to keep their finger on the pulse of the company's financial health. Liquidity management metrics serve as vital tools for measuring a company's ability to meet its short-term financial obligations and provide insights into the overall stability of the business.

While these metrics offer useful insights, it's important to remember that they should be used in conjunction with a broader understanding of the business and its finances.

No single metric tells the whole story — the context of your industry, business model, and growth stage are all important factors to consider when interpreting these ratios.

Current ratio

The current ratio is a fundamental liquidity metric that measures a company's ability to pay off its short-term liabilities with its current assets. It's calculated using the formula:

Current Ratio = Current Assets / Current Liabilities

A current ratio of 2:1 is often considered ideal, meaning the company has twice as many current assets as current liabilities. However, what constitutes a "good" current ratio can vary by industry. For example, retailers tend to carry substantial inventory that can be turned into cash relatively quickly, allowing them to operate comfortably with a lower current ratio. In the retail industry, a current ratio between 1.5:1 and 2:1 may be considered healthy. However, tech companies or service-based businesses might aim for a higher current ratio, as they have fewer physical assets and inventory and rely more on cash and receivables to fund operations.

A high current ratio (above 3:1) might indicate that a company is not efficiently using its current assets or short-term financing options. Conversely, a low current ratio (below 1:1) could suggest that the company may struggle to meet its short-term obligations.

Quick ratio (Acid-test ratio)

The quick ratio, also known as the acid-test ratio, is a more stringent measure of liquidity. It excludes inventory from current assets, focusing on the most liquid assets. The formula is:

Quick Ratio = (Current Assets - Inventory) / Current Liabilities

This ratio provides a more conservative view of liquidity, as it assumes that inventory cannot be quickly converted to cash without a loss in value. A quick ratio of 1:1 or higher is generally considered good, indicating that the company can meet its current liabilities with its most liquid assets.

Cash ratio

The cash ratio is the most conservative liquidity metric, considering only cash and cash equivalents. It's calculated as:

Cash Ratio = (Cash + Cash Equivalents) / Current Liabilities

This ratio shows a company's ability to pay off its current liabilities with just the cash and cash equivalents on hand. While a high cash ratio indicates strong liquidity, it might also suggest that the company is not efficiently using its cash to generate returns.

Operating cash flow ratio

The operating cash flow ratio measures a company's ability to cover its current liabilities with the cash flow generated from its core business operations. The formula is:

Operating Cash Flow Ratio = Operating Cash Flow / Current Liabilities

This ratio provides insight into a company's ability to generate sufficient cash from its main business activities to cover its short-term debt. A ratio greater than 1 indicates that the company generated more cash from operations than needed to cover its current liabilities.

By regularly monitoring these key liquidity metrics, CFOs and treasurers can gain a comprehensive understanding of their company's liquidity position and improve cash flow. These metrics serve as early warning systems, helping to identify potential liquidity issues before they escalate into serious problems.

Tracking these metrics over time can reveal trends in the company's liquidity position, allowing for proactive management of liquidity risks. For instance, if you notice a declining trend in your quick ratio, it might signal a need to reassess your inventory management or accounts receivable collection processes.

Remember, while these metrics are powerful tools in your liquidity management strategy, they should be interpreted in context. Factors such as industry norms and strategic goals should all be considered when evaluating your company's liquidity position.

Establish clear policies and procedures

Well-defined policies and procedures are the foundation of effective liquidity management. These guidelines should outline how cash flow, accounts receivable, and accounts payable are managed within your organization.

For instance, your liquidity management policy might specify target levels for key liquidity ratios, define the types of investments permitted for excess cash, and set out procedures for regular liquidity forecasting and reporting. Having these policies in place ensures consistency in your approach to liquidity management and reduces the risk of errors or oversight.

Maintain open communication

Effective liquidity management requires a holistic view of the organization's financial position. That requires open communication between different departments, along with reliable reporting software and accurate recordkeeping.

Finance teams should maintain regular dialogue with sales, operations, and other key departments to stay informed about factors that could impact cash flow. The sales team might provide insights into upcoming large contracts or potential delays in customer payments, while operations could alert finance to any anticipated large expenses or changes in inventory levels.

This cross-functional communication enables more accurate liquidity forecasting and allows for proactive management of potential cash flow issues.

Automate processes

AP automation for invoicing and bill payments saves time and reduces the risk of human error for finance teams. It also enables you to better control costs. When you automate invoice processing and payment scheduling, you can optimize payment timing, take advantage of early payment discounts, and avoid late fees.

Beyond that, AP automation helps ensure timely, accurate payments to keep your vendor relationships strong. When you pay your vendors on time, you’re less likely to encounter costly delays. You’ll also be in a better position to negotiate more favorable terms in the future.

The same goes for cash flow forecasting — through reliable automation, you can gain a better picture of your financials and restore bandwidth for more strategic initiatives.

For instance, automated accounts receivable software can send timely reminders to customers, potentially improving collection rates and reducing days sales outstanding (DSO). Similarly, automated cash flow forecasting tools can integrate data from various sources to provide real-time visibility into your liquidity position.

Monitor key metrics regularly

Regular monitoring of key liquidity metrics is crucial for identifying potential issues early and making informed decisions. In addition to calculating the ratios discussed earlier, you must understand the trends and factors influencing these metrics.

Consider setting up a dashboard that provides a real-time view of your key liquidity indicators. This could include the standard ratios as well as metrics specific to your business like daily cash balances and upcoming large payments (both incoming and outgoing).

Maintain a diversified funding mix

Relying on a single source of funding can leave your business vulnerable to liquidity risks. Maintaining a diversified funding mix, including both short-term (e.g., credit lines) and long-term (e.g., term loans) options, provides greater flexibility to meet different financial needs.

For example, a company might use revolving credit for day-to-day working capital while relying on longer-term debt for major expenditures. This provides access to funding sources for different purposes and reduces the risk of a liquidity crunch if one source becomes unavailable.

Develop accurate cash flow projections

Accurate cash flow forecasting is the cornerstone of effective liquidity management. It involves predicting future cash inflows and outflows to anticipate potential surpluses or shortfalls.

To improve the accuracy of your forecasts, consider using a combination of methods:

1. Historical data analysis: Look at past trends to inform future projections.

2. Scenario planning: Develop multiple scenarios (best case, worst case, most likely) to prepare for different outcomes.

3. Industry benchmarks: Compare your projections with industry standards and peer performance to ensure realistic forecasts

4. Rolling forecasts: Regularly update your forecasts as new information becomes available.

Maintain a healthy debt-to-equity ratio

A healthy debt-to-equity ratio (D/E) shows that you have financial stability and access to funding when needed. The optimal ratio varies by industry, but a lower ratio indicates less financial risk.

You can improve your D/E by negotiating with lenders for more favorable loan terms, such as lower interest rates or flexible repayment schedules. It’s also wise to diversify your funding sources so your company is not reliant on a single lender. Maintain good relationships with multiple lenders to ensure access to financing in the future.

Keep a liquidity buffer set aside

Low-risk, highly liquid assets like marketable securities or money market accounts provide a safety net for unexpected expenses or revenue shortfalls.

Develop a liquidity policy that defines an optimal level of highly liquid cash. Review and adjust your liquidity buffer regularly to ensure that you are adequately prepared for changing business needs and market conditions.

By implementing these best practices, CFOs and treasurers can develop a robust liquidity management system that not only safeguards their organization's financial health but also positions it for sustainable growth. Remember, effective liquidity management is an ongoing process that requires regular attention and adjustment as your business evolves.

Effective liquidity management is crucial at every stage of a business's lifecycle, but the strategies and focus areas may shift as a company grows and evolves.

Here’s a look at how liquidity management needs and approaches may change over time.

Startups and early-stage businesses

For startups and early-stage businesses, managing liquidity often means walking a tightrope between funding growth and maintaining sufficient cash reserves. These companies typically face challenges such as limited cash flow and restricted access to credit.

Key liquidity management strategies for startups include:

• Bootstrapping: Using personal funds (or operating revenue) while carefully managing expenses and reinvesting profits to fuel growth.
• Securing angel investors or venture capital: This can provide necessary capital injections, but it's crucial to manage these funds wisely.
• Diligent receivables management: Implementing strict collection policies to ensure timely payment from customers.
• Negotiating favorable payment terms with suppliers: This can help extend your cash runway.
• Equity compensation: Companies can conserve cash and still hire top talent by offering equity or ESOPs.

Mid-market businesses

Liquidity needs can increase sharply as a business expands operations, enters new markets, or launches new products.

For mid-market businesses, liquidity management might involve:

• Implementing more sophisticated cash flow forecasting techniques to anticipate needs across various business units or product lines.
• Exploring diverse funding options, such as lines of credit, term loans, or even considering an IPO.
• Improving working capital by optimizing inventory management and negotiating better terms with suppliers and customers.
• Investing in global treasury management software to handle more complex financial operations.

Consider the case of a rapidly growing e-commerce company. As it scales, it might need to invest in larger inventory holdings and new warehouses. Effective liquidity management would involve balancing these hefty investments by maintaining sufficient cash for day-to-day operations.

Enterprise businesses

Enterprise businesses have a little more room to operate. For these companies, liquidity management is less about survival and more about optimizing returns on excess cash. A proper liquidity management strategy also helps to brace for potential market disruptions.

Enterprise businesses develop investment strategies for excess cash to balance risk and return. They also use their robust cash flows for strategic initiatives such as share buybacks, increasing dividends, or funding acquisitions. At the same time, they maintain substantial liquidity buffers to weather market downturns or disruptive events to stay resilient.

Regardless of the business stage, the core principle of liquidity management remains the same: ensuring the company has sufficient cash on hand to meet its obligations while maximizing its available resources. However, the tools, strategies, and focus areas will evolve as the business grows and matures.

Effective liquidity management isn't just a financial necessity—it's a strategic imperative driving business success and resilience. As we've emphasized throughout this guide, managing liquidity extends beyond simply having cash on hand. It demands a comprehensive approach to understanding, forecasting, and optimizing your company's financial resources:

1. Monitor key metrics regularly: Keep a close eye on your current ratio, quick ratio, and operating cash flow ratio. These provide crucial insights into your company's liquidity position.
2. Balance your liquidity buffer: Maintain enough cash to meet obligations while avoiding excess idle funds. It's a delicate balancing act, but critical for financial health.
3. Evolve with your business: As your company grows, so will your liquidity management needs. Continuously adapt your strategies to match your current business stage.
4. Embrace technology: Leverage modern liquidity management software to automate processes, enhance accuracy, and gain real-time insights into your cash position.
5. Foster cross-functional communication: Ensure your finance team maintains ongoing dialogue with other departments to anticipate potential impacts on cash flow.
6. Diversify funding sources: Remember, liquidity equals flexibility. Don't rely on a single source—cultivate relationships with multiple lenders and explore various financing options.
7. Refine your forecasting: Invest in both tools and talent to improve the accuracy of your cash flow projections.

By implementing these strategies, you'll be well-equipped to navigate the complexities of liquidity management and drive your business towards sustainable growth.

As you implement these strategies, consider how a comprehensive liquidity management solution like Brex can simplify your efforts. Brex offers powerful financial services and software for cash management, spend control, and financial visibility, enabling CFOs and treasurers to make informed decisions and optimize their liquidity positions.

Brex's automated expense management tools further improve financial operations, saving time and reducing the risk of costly human errors. Brex AI automatically categorizes expenses as they occur, significantly cutting down on manual data entry. And, with automated receipt matching and pre-populated memos, you’ll have accurate data across your expense reports.

Beyond that, Brex corporate cards can provide your business with access to high credit limits — up to 10-20x higher than legacy cards — ensuring access to the capital you need. Plus, with built-in expense controls, customizable spend limits, and approval workflows, you can protect your company's liquidity while still empowering employees to move fast.

Another big perk: Brex’s automated bill payment software can save you hours and ensure accuracy to avoid costly service delays. Plus, you can earn rewards or cash back by paying with your Brex corporate card.

Brex's banking solution — checking, treasury, and vault in one account — can help you grow your liquid cash reserves and extend your runway as you earn high yield via money market funds. With a Brex business bank account, you won’t have to worry about hidden bank fees eating into your cash reserves. And you’ll have industry-leading protection — Brex provides up to $6M in FDIC coverage through 20+ program banks.

“Brex is so fast and easy to use that I don't have to spend time worrying about our finances. I can instantly move money from our cash account to our card, plus the longer payment terms help with our cash flow." — Ori Zohar, Co-Founder and Co-CEO, Burlap and Barrel

By leveraging Brex's comprehensive suite of tools, companies can not only manage their liquidity more effectively but also optimize their overall financial operations. From automating routine tasks to providing strategic insights, Brex empowers CFOs and treasurers to maintain robust liquidity positions while driving business growth.

By implementing the strategies and best practices outlined in this guide — and leveraging modern solutions like Brex — you can ensure your company maintains the financial agility it needs to succeed, no matter what lies ahead.