Thriving vs. Surviving? Wise Liquidity Management Moves for Businesses in All Seasons

March 13, 2023 |
Article | 8 min
| Business Insights

The economic forecast may be uncertain, but preparing for potentially inflated rates is the smartest course of action. Liquidity management is a lot of work, but the benefits can help your business thrive rather than survive. Learn more about how you can keep your business afloat in every season.

A fluctuating economic environment, such as the one we’re currently experiencing, has historically pointed toward the imminent possibility of a recession. While forecasts aren’t 100% reliable, proactive leaders should prepare for future economic turmoil by reimagining their company’s liquidity management.

Should low or transitory inflation levels persist, the economy may experience a prolonged period of stagflation—high inflation, high unemployment, and slow economic growth—or even deflation. As such, variable interest rate environments may throw your costs off balance.

Under these economic conditions, weathering the gathering storm is a matter of preparation. Streamlining your cash flow can build resistance against outside economic forces.

It is possible to increase your working capital without bringing in additional revenue. You simply need to increase the efficiency of your cash conversion cycle (CCC). Regardless of whether inflation persists, you’ll benefit immensely from addressing stagnations within your CCC. And should a recession occur, companies with increased access to working capital will hold a significant advantage.

There are several strategic liquidity management moves you can make during this preparatory season to shore up your company’s financial health. The following key steps can help you remain agile in a challenging environment.

Company trying to perform liquidity management

1. Improve Visibility on Your Current Financial Performance

Your financial data provides a comprehensive overview of your CCC and empowers you to identify and address otherwise unnoticed issues. Visible treasury data enables you to leverage your internal insights to adapt more quickly—a feature that can make or break businesses in a volatile economic environment.

However, finding the right liquidity management techniques for your CCC requires a detailed understanding of your position. So, to this end, let’s review some of the key terms and factors that will determine which strategic course of action is most viable for your company.

Liquidity Management and Measurements

First, a quick overview of the fundamentals. A company’s liquidity is measured by the ratio of assets that can be converted to cash against debts due over the next year.

Volatile markets have significant impacts on this ratio. For example, liquidation might take extended periods due to factors like supply chain backups.

Liquidity management refers to the oversight of working capital to meet a company’s financial obligations and, hopefully, optimize its yields.

company in a meeting about cash flow liquidity management

Cash Conversion Cycle Overview

Your cash conversion cycle is a simple calculation of how long you can bear the costs of making or providing your goods or services before you receive payment. Shorter cycles add value to a company by increasing liquidity and enjoying fewer funding requirements.

Optimizing your CCC is the process of streamlining cash flows to increase the amount of working capital your company has access to at any moment. Three essential elements form the CCC:

Days Inventory Outstanding (DIO)

Days Inventory Outstanding (DIO) measures how long it takes to convert raw materials into products or services. Issues with DIO management can result in unnecessary inventory storage costs or supply chain delays.

Reducing the time frame of your DIO contributes to a lower CCC, as capital spends less time tied up in physical products. However, many companies are rethinking the just-in-time approach after manufacturing bottlenecks disrupted their operations during the Covid-19 pandemic.

Days Sales Outstanding (DSO)

Days Sales Outstanding (DSO) tracks the average time you collect payments after a sale. Reducing your DSO is also advantageous because it accelerates receivables and increases the speed of your CCC.

Digital solutions that automate accounts receivable (AR) department processes can drive down time frames by increasing customer convenience and speeding up transactions.

Days Payable Outstanding (DPO)

Days Payable Outstanding (DPO) describes the average amount of time it takes for your company to pay suppliers after delivery. Expanding your DPO time frames contributes to an efficient CCC by keeping working capital in your company’s hands longer. Larger companies are often able to obtain extended payment terms from smaller suppliers.

banker discussing liquidity management details

Net Borrowers vs Net Investors

Net borrowers are organizations that borrow more than they lend or save. Over time, excessive debt accumulation can lead to an unmanageable burden, especially in volatile economies with rising interest rates.

Some industries necessitate operating as net borrowers. In these cases, high liquidity management is needed to meet obligations. Optimizing your CCC is critical when operating within this business framework.

Net investors, on the other hand, generate enough capital to cover their costs, making them more resistant to volatile interest rates. However, net investors aren’t immune to economic challenges. CCC optimization can still protect them from market changes. Plus, shortening the cycle can yield significant returns.

2. Establish Working Capital Benchmarks for Your Business

Establishing benchmarks to measure your financial performance is one of the best ways to streamline your capital management. No company can maintain viability if, in the long term, its cash inflows don’t exceed its cash outflows.

CEO discussing capital benchmarks with his team

In other words, there must be enough incoming capital to meet obligations. This is known as a positive cash flow. It differs from profitability, yet it’s an essential metric to track. Maintaining access to working capital to fund operations is critical.

Benchmarks generally compare your industry competitors’ performance against your own. The goal is to find operational lags or issues with your cash flow that could impact your long-term financial health. Because the measurement is industry-specific, you’ll need to determine which metrics are meaningful to optimize your operations fully.

For instance, businesses without inventory, such as software companies, will obviously not need to track their DIO. However, because liquidity management is critical across industries, slimming down your CCC can be done by examining several cash flow key performance indicators (KPIs).

Most notably, reducing your DSO and increasing your DPO significantly shortens your CCC. As a result, you can increase your positive cash flow. However, extending your DPO too far puts your future credit terms at risk. So, if your DPO benchmark falls behind the industry standard, you should renegotiate better terms.

man handling liquidity management benchmarks for his business

Of course, the other half of the equation is to set your DSO against similar industry benchmarks. If you’re experiencing delays relative to these industry standards, you should investigate faster ways to collect. Or, you could perhaps offer incentives to encourage early payments.

Your company will have unique benchmarks to track and compare. An experienced financial partner can help you set and manage your cash flow KPIs.

3. Optimize Working Capital Management Through Technology

Across different industries, companies are quickly turning to digital solutions for liquidity management and CCC optimization. The Covid-19 pandemic only accelerated the digitization of treasury management systems, as efficient remote processes became operationally critical.

Today, many companies still use manual or paper processes in their accounts payable (AP) and AR departments. Although, companies clinging to these outdated systems likely won’t be able to compete with those using artificial intelligence (AI)-driven automation to increase speed, accuracy, and data visibility.

Modern treasury technology is beneficial in a volatile economic environment. The comprehensive information sets generated from sophisticated digital treasury systems can provide the necessary information to compare your results with relevant industry benchmarks.

In fact, through advanced technology, you can carefully navigate an inflationary cycle with meticulous liquidity management to potentially gain a competitive edge.

Liquidity Management Across Industries

Of course, while treasury technology advances are ideal across sectors, your industry will largely determine the best approach to optimize your working capital management.

Executive handling cash flow

For instance, retail companies' most common cash flow bottleneck is the gap between inventory purchases and sales. This can be extensive, especially when gearing up for the holiday season.

Treasury technology can help solve these issues by streamlining your accounting processes and freeing up your AP department’s time to focus on supplier relationships. Negotiating better terms may also help retail businesses avoid borrowing from a bank to cover costs.

On the other hand, manufacturing companies that sell goods on credit commonly experience cash outflow issues. This is because significant costs are incurred during the manufacturing process.

In response, manufacturers can use their convenient treasury technology to request payment prior to production. This can greatly reduce manufacturing CCCs and increase access to working capital.

4. Unlock “Trapped” Cash

The ultimate effect of modern treasury management technology is to free up stagnant cash flows by empowering you with greater data visibility and benchmark tracking.

One of the most obvious negative consequences of financial data silos between departments is that it reduces the cohesion of your corporate accounting department’s communications. This results in increased errors.

Executive unlocking trapped cash with modern treasury management

Analytics are increasingly used to optimize decision-making. As a result, companies that don’t adopt a unified system that produces comprehensive data sets can easily fall behind.

Treasury technology is quickly taking over as the foremost tool for liquidity management. So, let’s see how the use of data can optimize your CCC:

  • Improving Collections: Accurate and up-to-date reporting on collectibles is critical for your receivables, as proactively addressing missing payments is impossible without knowing which payments are late. Technology can further assist collection efforts by automating reminders and offering predetermined incentives for early payments.
  • Increasing Float: Float refers to the period during which transaction processing delays result in a double count of funds. More precise automated payment times can help you optimize your incoming cash flow to accrue interest or gain time before payments are processed.
  • Improving Operational Efficiency: Thanks to the introduction of advanced digital treasury tools, paper or manual processing in AP or AR departments is quickly becoming a waste of time. Administrative work can be done more quickly and accurately by AI. Digital systems free your staff to work on more complex and goal-oriented issues like streamlining your CCC and reducing unnecessary expenses.

Data analytics is the future of financial decision-making, but many companies haven’t yet adopted an information-based approach. So, early system upgrades can potentially confer exceptional competitive advantages at the moment.

5. Strengthen Relationships with Banks and Financial Partners

Strengthening your relationship with your local bank is one of the most important (yet often overlooked) preparatory measures you should take in any economic climate, but especially if hard times are predicted.

Executives working with their banker

Demonstrating your proactive liquidity management and holding early discussions about potential risks can build trust. It may even yield advantages such as favorable terms, reduced interest rates, and more capital.

The experienced financial partners at your local bank branch can be sound resources when you experience cash flow issues. Your bank wants to help you reach your financial goals, so you can get personalized expert advice on your unique situation. But first, you need to reach out and brief them on your company’s strategies and finances.

Your local bank’s liquidity management experts can help you set your industry benchmarks and implement tracking technology to measure your performance. They can also work with you set your finances in order. This includes granting you access to capital and helping you create a smart and strategic plan for optimizing operations.

Learning how to leverage new treasury technology can be intimidating, but a local financial partner can help you through the digital transition.

Consult with an Expert to Optimize Your Liquidity Management

The economic forecast may be uncertain, but preparing for potentially inflated rates is the smartest course of action at this point.

The five steps outlined in this article—improving visibility, establishing benchmarks, optimizing working capital management, unlocking trapped cash, and strengthening your relationship with your local bank—are vital responses to volatile markets. Of course, they offer significant advantages even under normal circumstances.

The business world is going digital, making manual or paper systems obsolete. Upgrading your treasury systems enables both automated increases in efficiency and data analytics. What’s more, optimizing your CCC requires extensive reporting capabilities within your system, so upgrading your processes is a competitive necessity.

The experts at Dubuque Bank & Trust, a division of HTLF Bank are here to help you increase your financial performance by optimizing your cash flow and increasing your access to working capital. They can help you strategize for future financial uncertainties and navigate issues like potential unchecked inflation. Get in touch with the trusted financial partners at Dubuque Bank & Trust, a division of HTLF Bank today.