What is Liquidity Risk Management?
According to the Federal Reserve, “The primary role of liquidity risk management is to (1) prospectively assess the need for funds to meet obligations and (2) ensure the availability of cash or collateral to fulfill those needs at the appropriate time by coordinating the various sources of funds available to the institution under normal and stressed conditions.”
This can become quite a challenging task if you are still managing your cash operations in spreadsheets.
How Automating Cash Management Can Help Your Business
Management teams understand the importance of maintaining healthy liquidity. However, developing control and an accurate understanding of liquidity is a complex, ever-changing challenge, and liquidity management has a real impact, especially in the continuing aftermath of recessions, like the one we’ve experienced during the COVID-19 pandemic.
Does your company measure up? How are you handling liquidity risk management?
Understanding Liquidity Risk
What happens when a company faces a liquidity shortfall? A severe liquidity deficiency can cause a myriad of difficulties, from a fundamental inability to expand into new markets to a downward spiral of unpaid debts, denied credit, emergency sales of needed assets, and the worst-case scenario: insolvency.
Cash flow is extremely dynamic and can be significantly affected by outflows such as wages, vendor payments, or other short-term obligations. If a company finds itself short on the necessary cash to meet these payments, the business’ growth can not only be stalled, but it can, in the worst case, fail.
Unpaid vendors and employees will turn elsewhere, while banks may call loans or refuse to extend needed credit. The ripple effect, if not contained, could sink the entire organization.
The Effect of a Recession on Liquidity Risk
In a healthy, relatively stable market, liquidity is more easily monitored and maintained. But in a depressed or volatile market, healthy and sufficient liquidity becomes imperative for survival.
As businesses worked through the COVID-19 crisis, volatility became the new normal. Across the globe, companies and individuals were bouncing back and forth between running on all cylinders and just scraping by.
With a high level of volatility and no end in sight, it’s more important than ever to manage liquidity risk as effectively and efficiently as possible. Business leaders must find solutions to address and mitigate liquidity shortfalls.
The Effect of a Bank Failure on Liquidity Risk
An important takeaway from the Silicon Valley Bank failure for startups is the importance of multibank cash management. Teams must not only diversify their investments, but the banks they partner with to hold deposits.
Having a mix of accounts at different banks will be one of the key ways to future-proof your liquidity management. By diversifying where you hold your cash, you can minimize the potential impact of a bank run.
The Challenge of Mitigating Liquidity Risk
The bedrock of risk management is having a clear understanding and ability to manage cash flow down to the dollar.
A company’s liquidity is typically spread across multiple accounts and assets, meaning various account statements and overviews have to be analyzed to develop a full picture of cash health.
This is further complicated by the fact that, for most businesses, multiple agents and departments are responsible for expenditures and inflow.
Due to the lengthy and manual nature of cash analysis, standard practice is to assume that even the best models and projections will lack precision.
Bank API Software Solutions: Easy and Effective
New technological advances are allowing businesses to manage cash flow in an increasingly granular yet accessible way.
With automated cash management platforms, like Trovata, bank data across your multitude of accounts are aggregated and normalized in one, secure platform.
This way, you can build comprehensive reports and forecasts that provide deeper, rich insights into your organization’s cash flow. With that in mind, there’s every reason to take an aggressive approach to monitoring liquidity risk.
To do this, business leaders in today’s economy should build responsive frameworks for liquidity risk management. These frameworks should include:
- Chains of responsibility: From the CFO to treasurers, every person in the company who can make decisions that can affect liquidity in any way should be placed into a logical chain of command to facilitate reporting and responsibility.
- Projected scenarios: It’s clear from the response to COVID-19 that liquidity risk management is an evolving discipline. One of the common mistakes businesses made before the pandemic was a failure to envision the effect of a global catastrophe. Moving forward, liquidity risk management frameworks should make every effort to plan for anything, from operating in a healthy, thriving market to the effect of extreme crises.
- Plans for cushioning the company from all levels of risk: Maintaining cash reserves will become an essential business practice in the future. However, other methods of protecting against shocks to the system, such as diversifying inflow streams by widening customer bases, will also need to be implemented.
- Continuous Forecast Testing: These scenarios and solutions should be subjected to rigorous, regular scrutiny in the same way that any other safety procedures must be tested. Regularly revisiting the framework, and developing the ability to pivot and react to current events quickly, is the only way to ensure that the company is protected adequately from future shocks.
Trovata Can Help You Manage Cash With Precision
At the forefront of automated cash management, Trovata is helping businesses better understand and analyze their liquidity. By integrating directly with financial institutions’ bank APIs, Trovata automates the aggregation of your transaction data across all your bank accounts, eliminating tedious data management workflows. This not only saves time and resources, but it assures that these crucial reports are accurate and delivered quickly.
Trovata’s intuitive and innovative solution makes it possible to:
- Automate cash forecasting and reporting. Cash forecasting and cash reporting are complex calculations that require considerable time and resources. A nightmare of spreadsheets, phone calls, analysis, and verification can now be streamlined using Trovata’s intelligent API-powered software.
- Consolidate and normalize your data. Trovata takes all of the crucial components of your company’s cash data and synthesizes them into an accurate, real-time report that’s accessible anytime, anywhere. Want more detail? Trovata allows you to drill down, access granular data, and define your variables.
- Get started immediately. Trovata is an out-of-the-box solution, with no implementation downtime or IT involvement necessary. Your treasury department can be up and running with Trovata’s agile, intuitive software powered by open banking APIs in under an hour.
In times of financial crisis, leaders need to take the reins confidently. Trovata is here to make that possible, with granular, accurate, bank data at your fingertips.
Download the Essential Treasury Reporting and Forecasting Guide to learn how Trovata can help you strengthen your liquidity strategy.