Table Of ContentThe Association of Corporate Treasurers
The Association of Corporate Treasurers is a professional
body, formed in May 1979, to encourage and promote the
study and practice of finance and treasury management, and to
educate and train those involved in this field. The Association
currently has 1800 Members, 600 Associates and more than
1500 students. It is the only UK body which concentrates and
sets professional examinations exclusively on the subject of
finance and treasury management. The Association is an inde
pendent body, governed by a Council of Members whose work
is supported by a number of active voluntary committees.
Managing liquidity
Second edition
Lance Moir
W O O D H E AD P U B L I S H I NG L I M I T ED
and
THE ASSOCIATION OF
CORPORATE TREASURERS
Published by Woodhead Publishing Ltd and
The Association of Corporate Treasurers
Woodhead Publishing Ltd
Abington Hall, Abington
Cambridge CB1 6AH, England
First published 1992, Blackwell Publishers
Reprinted 1996, Woodhead Publishing Ltd
Second edition 1997, Woodhead Publishing Ltd
© 1997, Woodhead Publishing Ltd and The Association of Corporate Treasurers
The author has asserted his moral rights
Conditions of sale
All rights reserved. No part of this publication may be reproduced or transmitted in any
form or by any means, electronic or mechanical, including photocopy, recording, or
any information storage and retrieval system, without permission in writing from the
publisher.
While a great deal of care has been taken to provide accurate and current information,
neither the author, nor the publisher, nor anyone else associated with this publication,
shall be liable for any loss, damage or liability directly or indirectly caused, or alleged to
be caused, by this book.
British Library Cataloguing in Publication Data
A catalogue record for this book is available from the British Library.
ISBN 1 85573 335 8
Typeset by Best-set Typesetter Ltd, Hong Kong
Printed by St Edmundsbury Press, Bury St Edmunds, Suffolk, England
Preface
This book has been written in order to describe how the basic
management of liquidity operates in companies — both domes
tic and multinational. In particular, it attempts to set some of
the basic decisions in liquidity management (how much do I
deposit, for how long and at what rate) in the overall business
context.
However, it does not claim to be a complete study of liquid
ity. In particular, the details of money transmission, debtor and
creditor control and international trade finance are excluded,
while there is only a rudimentary examination of short term
deposit and borrowing instruments.
It is written not only for the student of treasury management,
but also for non-financial executives who need to know what
liquidity management is all about. It should also be useful for
the small business person who will meet the concepts of liquid
ity management every day.
Liquidity is only part of treasury management, and so cer
tain problems which arise from a lack of liquidity naturally lead
directly on to the ability to raise debt and other issues. Funding
management and corporate finance and these developments
are deliberately beyond the scope of this book. Nevertheless,
surrounding events have to be considered when applying any
liquidity management technique, but I hope that this book
places liquidity management in the general business context
ix
Preface
and will be suitable both for the treasury specialist and general
business person alike.
Since the first edition was published in 1992, the use of
liquidity instruments and, in particular, interest rate hedging
has developed considerably. This has been a period when
sterling left the ERM and the markets learned the true mean
ing of volatility and when a number of large companies
throughout the world have lost money using derivatives. The
second edition of this book looks at interest rate hedging in
much more detail and also sets out more control mechanisms
which have been developed by the ACT and other bodies.
Liquidity management now fits more closely with currency
management and other aspects of money management. This
book, however, tries to pull out the essential elements of liquid
ity management which remains at the beginning of all treasury
management - without available cash, the business will fail.
I am grateful for the continuing support of all the staff at the
Association of Corporate Treasurers.
This edition is dedicated to the memory of my parents,
Renee and James Moir.
Lance Moir
June 1997
x
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What is liquidity and how
does it arise?
• The definition of liquidity
• The broad objectives of liquidity management
• How liquidity impacts on a business
What is liquidity?
The liquidity of an organisation is the ability to make payments
as they fall due. Perhaps more important are the consequences
of illiquidity which are likely to lead to a business ceasing to
trade.
A company may be highly profitable in an accounting sense,
but this is of no use if there is no cash to pay employees and
suppliers and no cash to make further investments. Conversely,
a company which is making large accounting losses may be
generating substantial cash (e.g. early in the 1980s Courtaulds
made substantial accounting losses, yet generated millions of
pounds before repaying loans and paying dividends). This may
be the result of writing off assets or by creating accounting
provisions as well as high levels of depreciation.
Although the availability of liquidity to a company is the
prime objective, that liquidity also requires active management
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Managing liquidity
in order to benefit the company in a financial sense, but also to
avoid and minimise risk.
The scope of liquidity management usually extends to the
management and control of:
• cash flow and cash flow forecasting;
• investments and borrowings of up to 1 year;
• availability of borrowing facilities;
• short term interest rate management.
It will also cover detailed applications including money trans
mission, and debtor and creditor management.
How does liquidity arise?
In order to manage effectively a company's liquidity, it is
important to understand how it arises and the uses that it is put
to. In particular, there is a need to understand the dynamics of
the business, particularly in so far as these affect the cash flow.
For example, as sales grow, a business must assess how much
extra cash is consumed by working capital (or, less commonly,
for some businesses such as large food retailers, how much cash
is generated).
As part of the normal business cycle, liquidity arises:
1 By generating profits in cash terms; that is, through selling
goods for cash in excess of that required to produce them. This
will be made up of a number of cash flows, both in and out:
(a) cash sales;
(b) receipts from debtors;
(c) payments to creditors;
(d) operating costs;
(e) capital invested;
(f) dividend and interest payments.
2
What is liquidity and how does it arise?
Naturally it follows that if the business is either growing or
inefficient, then liquidity is consumed rather than generated.
Inefficiency also includes increasing stock levels greater than
needed to meet sales. Stock positions, however, arise as a com
bination of the purchase of raw materials and slow cash sales
rather than as cash movement in themselves.
2 By selling for cash assets that are no longer necessary.
3 By raising funds (either debt or equity) in excess of the amount
needed for investment by the company at that time. This might
typically happen where a company has a planned expansion
programme and decides that it would be prudent to raise the
necessary finance in advance (e.g. pharmaceutical development
or oil exploration).
Liquidity is consumed:
1 By making new investments in fixed assets, or acquiring busi
nesses.
2 By increasing working capital in order to expand sales or im
prove margins.
3 By making losses in excess of the depreciation (and other non
cash) charge.
These are the factors that affect liquidity over a long term
business cycle, but on a day-to-day basis, more significant
factors are likely to be receipts and major payments to suppliers
or for payroll. For many small businesses, it is items such as
these that really represent liquidity.
It is important to note the emphasis on cash in the above
lists. The amount of cash available can be measured unam
biguously, whereas other accounting treatments can be more
subjective. The amount of cash used in working capital is
particularly important and in situations of illiquidity it is often
working capital that can be squeezed first to generate liquidity,
where other assets will take longer to realise.
3
Managing liquidity
For many businesses, the emphasis in liquidity management
is associated with working capital management - that is, ensuring
that payments from debtors are received swiftly, stocks mini
mised and payments to creditors delayed until the latest com
mercially sensible date. However, the key feature of liquidity
management is the availability of liquidity, therefore for busi
nesses which are not trading at their limit, this is often the
borrowing facilities available, typically overdrafts for small
businesses (but also committed borrowing facilities for larger
companies) or investments that are liquid, such as bank certifi
cates of deposit or quoted securities.
How does liquidity management fit into
treasury policy?
Every business should have a clear set of treasury policies that
establish the board's attitude towards the various treasury ac
tivities, such as the level of risk to be adopted, the level of
gearing (and therefore the amount of debt to be raised) and
who is authorised to deal on the company's behalf. Within
these policies, there should be sections setting out the policy
towards liquidity management, in particular covering:
• cash management;
• short term investment management;
• short term interest rate management;
• money transmission management.
These policies cannot stand independent of the total treasury
activity - for example, short term interest rate management
should fit with the overall risk profile. Money transmission will
depend upon the group's attitude to centralisation — do all
4
What is liquidity and how does it arise?
international payments net through a centre or are they man
aged locally?
The objectives of cash management policy
The policy on cash management for a large group should
comprise at least the following:
1 A brief description of the origins of short term cash and funding
positions around the company.
2 The objectives of the policy, for example to provide adequate
and cost effective banking services for the company and its
subsidiaries by:
(a) minimising the level of funds in subsidiaries while ensuring
the provision of short term financing for day-to-day work
ing capital requirements;
(b) maximising the income from short term surpluses held in
bank accounts, and minimising the cost of short term
deficits, through active management of bank account
balances;
(c) ensuring that, where possible, the most efficient and cost
effective banking practices are observed.
3 A standard for the bank account configurations across the
company. This should define the optimum number of banks to
be used and the cash management facilities that should be
provided, interfacing with group-wide systems where appropri
ate, including netting and pooling (see Chapter 4).
4 The standards for local treasury dealing facilities, where re
quired, including overdrafts, deposits and foreign exchange
dealing lines, including a company-wide standard bank
mandate.
5 Policy on the use of parent company guarantees, letters of
comfort and other support agreements.
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