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What is Liquidity Management?
Many businesses in the corporate world tie too much of their value in assets which are inventory, real estate and equipment of the firm. Although, having assets is an important part of organizations, having too low cash in hand could be catastrophic for all businesses. This, short term cash held for sudden and smaller necessities is known as liquidity of a firm.
As is obvious, managing liquidity is a separate process or financial function organizations have to deal with on a day to day basis. And though it seems like a child's play, in reality managing liquidity is one of the most complex processes the companies face in general.
Note − Managing liquidity is one of the most common and essential tasks of accountants and finance managers.
Why is Liquidity Management important?
Liquidity Management (LM) is necessary for companies to work smoothly meeting the short term expenditures without having to care too much. There is a need of LM to keep the business on track as the business grows and occurs expenses during its running days.
For example, a company must have cash for payroll, rent and recovery of assets. If a company needs to wait for too long to get cash, it might eventually lose many opportunities or go bankrupt in the longer term.
On the other hand, if the companies are over-leveraged by cash, they need to have a LM strategy to put the extra cash into debt obligations. The global crisis has shown many aspects of finance management failure but is has opened many eyes for searching a management policy regarding liquidity and debt payment balances.
Note − The global crisis showed the vulnerabilities of liquidity management to finance managers.
After the global crisis, the regulators and investors started to look for better financial managers, better policies and access to firms that has abetter liquidity-risk policy. In other words, the firms started to prefer companies that have a better risk management portfolio. This push was sufficient for the financial managers to look for better alternatives.
However, as the crisis was sudden and managers had not much time to handle it, the community now has started planning about liquidity management better to stay immune from events such as global recession. For this balancing real assets and liquidity are more important than raising cash for the firm.
Companies usually need to balance outflows and inflows of liquidity on a day-to-day basis too. Businesses often find that they need to check the financial needs of this short-term function in order to make the firm immune from instantaneous risks arising in the market.
Note − Meeting short-term and instantaneous needs is as important as meeting long-term ones.
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