How to Fortify Your Liquidity Management Strategy

Written by Keegan Chamberlin
August 19, 2021

The key to running a successful business is ensuring you have enough cash on hand to cover your operating expenses. 90% of all startups fail, many because they misjudge the operating income needed to meet the demands of their business. Even established and profitable businesses can be forced to close their doors if they do not manage their liquidity properly.

Crafting and implementing a liquidity management strategy ensures that your organization has a plan to meet its short and long-term obligations without experiencing significant losses. An effective strategy identifies liquidity risks at both the institutional and market levels and incorporates contingency plans to help your organization to overcome these challenges.

Yet without having a real-time view of your cash flow and position, your strategy may be based on faulty assumptions given yesterday’s data. Utilizing an automated cash management platform that provides real-time insights into your cash and follows best practices will empower you to fortify your organization’s liquidity management strategy.

Gain Real-Time Visibility Into Your Cash Flow and Position

Many organizations continue to limit their ability to monitor liquidity because they rely on manual processes to consolidate and normalize their cash and transaction data. These repetitive data normalization cycles are time-consuming and prone to costly human error. Delays in collating your data lead to management making liquidity assumptions based on incomplete, unreliable, and outdated data.

These inefficiencies are leading more and more organizations to adopt automation technologies, particularly single platforms that meet all their integration and automation needs.

In fact, 94% of business professionals report that they would rather use a unified platform to integrate their applications and streamline their workflows than rely on several solutions. 

Our automated cash management platform, Trovata, makes it easy for businesses to monitor, analyze, and automate their cash workflows such as cash reporting, analysis, and forecasting. Direct-to-Bank APIs automate the consolidation and normalization of your transaction and cash data from your many banks, empowering you with a real-time view of your cash flow and position.

That real-time view amplifies your ability to make data-driven decisions and strengthen your liquidity management strategy.

Identify Liquidity Risks Through Forecasting

To develop a sound liquidity management strategy, it is crucial to identify potential risks that could negatively impact your cash flows in the future.

As Deloitte notes in their recent report “Scenario and Action Planning,” many traditional planning and forecasting methods rely on “outdated assumptions and overly complex plans, hampered by inflexible processes that make it difficult to respond with the necessary speed.”

Dr. Florian Klein and Tobias Witzemann recommend “framing your rapid response with the four most relevant and distinct future scenarios, spelling out the specific risks and opportunities in each case.”

Once you establish your organization’s four most common liquidity scenarios, you must analyze how they might affect your financial health. Create forecasts for each scenario and ensure that you address how each risk could affect your future liquidity levels. 

Trovata automates many cash forecasting processes and equips you with advanced scenario planning capabilities that allow you to apply growth rates and variables to your automated forecasts. These capabilities enable you to easily forecast around different business decisions and potential investments.  

Conduct Regular Stress Tests to Discover Flaws in Your Liquidity Management Strategy

Stress tests are computer simulation techniques to test the resilience of organizations and their assets against potential financial risks. It is crucial to conduct stress tests regularly using a broad range of scenarios like organization-specific and market-wide stress scenarios.

There are several different types of stress testing techniques you can utilize to test and strengthen your liquidity management strategy. These include:

  • Historical statistical approach. This approach forecasts future cash flows based on growth rates from your previous historical cash flow. This stress test may not provide the most accurate data if drastic changes occur in the market, so you’ll want to keep that in mind.

  • Deterministic models. These models forecast the effects of forward-looking or historical-based liquidity stress scenarios to demonstrate potential internal and external situations that could affect your liquidity.

  • Monte Carlo simulation. This technique utilizes simulation modeling to assess various outcomes given specific variables. If you wanted to test the potential growth rates of a new product, you could utilize Monte Carlo simulations to see how those growth rates would affect your overall liquidity.

These tests help stakeholders to determine how exposed an organization is in the event of any imaginable scenario. As the COVID-19 pandemic has made painfully clear, organizations must expand the scope of their stress tests to include potential outcomes that were previously considered impossible. With this data, management can set specific liquidity limits and create contingency plans to address liquidity shortfalls.

Utilize Contingency Plans to Better Manage Liquidity

As Rachel Bryant, from the Federal Reserve Bank of Atlanta notes, a contingency plan is “a liquidity crisis management instrument and document that is prepared as a directive for a future emergency and stands ready to be referenced, someday, as a response plan and potential forecast of how a distant liquidity event may unfold.”  

A well-thought-out contingency plan links stress test results and other relevant information to help govern decision-making by providing contingent liquidity actions. Having these plans written down ensures transparency throughout your organization and empowers C-suite executives to make better and more informed decisions based upon real-time cash insights that develop out of your contingency plans.

Strengthen Your Liquidity Management Strategy with Trovata

Every business, regardless of its size or industry, requires sufficient cash on hand to meet its operating expenses. A sound liquidity management strategy ensures that your business can weather both internal and external risk scenarios.

But your liquidity management strategy is only as good as the data it relies on. Legacy systems and manual processes provide you with incomplete and inaccurate data, which leads to potentially making decisions based on faulty and costly assumptions. 

Trovata automates the aggregation of transaction data from your many banks, empowering you with real-time cash flow and position insights that strengthen your liquidity management strategy.

Download the Trovata Platform Data Sheet to learn how Trovata makes it easy for businesses to automate cash reporting, forecasting, and analysis.

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