Management of Cash position and Liquidity

27/09/2022 0 By indiafreenotes

Cash and liquidity management is a sub-function of treasury management that aims to convert sales to available cash as soon as possible and at the lowest processing cost.

It’s a crucial component in treasury operations; operations which are concerned with maximising the benefits of surplus funds and minimising the cost of shortfalls through careful investment and considered borrowing.

Individuals and businesses have a wide range of offerings available across the financial marketplace to help with all types of cash management needs. Banks are typically a primary financial service provider for the custody of cash assets. There are also many different cash management solutions for individuals and businesses seeking to obtain the best return on cash assets or the most efficient use of cash comprehensively.

Cash Management Involve:

Cash management deals with all aspects of working capital management and involves many different tasks. The roles and responsibilities of this department include:

  • Forecasting the cash requirements of the business and preparing budgets.
  • Establishing necessary banking relationships and providing working capital finance security.
  • Managing the credit collection.
  • Ensuring that shortfalls are avoided or minimised and that the business can always meet its financial obligations.
  • Releasing trapped cash
  • Extracting liquidity from working capital
  • Releasing working capital

Functions of cash management

In an ideal scenario, an organization should be able to match its cash inflows to its cash outflows. Cash inflows majorly include account receivables and cash outflows majorly include account payables.

Practically, while cash outflows like payment to suppliers, operational expenses, payment to regulators are more or less certain, cash inflows can be tricky. So the functions of cash management can be explained as follows:

Inventory management

Higher stock in hand means trapped sales and trapped sales means less liquidity.  Hence, an organization must aim at faster stock out to ensure movement of cash.

Receivables Management

An organization raises invoices for its sales. In these cases, the credit period for receiving the cash can range between 30 – 90 days. Here, the organization has recorded the sales but has not yet received cash for the transactions. So the cash management function will ensure faster recovery of receivables to avoid a cash crunch.

If the average time for recovery is shorter, the organization will have enough cash in hand to make its payments. Timely payments ensure lesser costs (interests, penalties) to the organization. Receivables management also includes a robust mechanism for follow-ups. This will ensure faster recovery and it will also assist the business to predict bad debts and unforeseen situations.

Payables Management

While receivables management is one of the primary areas in the cash management function,  payables management is also important. Payables arise when the organization has made purchases on credit and needs to make payments for the same within a fixed time. 

An organization can take short-term credit from banks and financial institutions. However, these credit facilities come at a cost and therefore, an organization must ensure that they maintain a good liquidity position; this will help in timely repayments of debts.


While planning investments, the managers need to be very careful as they need to plan for future contingencies and also ensure profitability. For this, they must use efficient forecasting and management tools. When the cash inflows and outflows are efficiently managed it gives the firm good liquidity.

Short-term investments

Avoiding cash crunch, insolvency and ensuring financial stability are the main criterias of cash management. But it is equally important to invest the surplus cash in hand wisely. Despite being a liquid asset, idle cash does not generate any returns. While investing in short-term investments an organization must ensure liquidity and optimum returns.

Therefore, this decision needs to be taken with prudence.  Here, the quantum/amount of investment needs to be calculated and decided carefully. This caution is necessary because an organization cannot invest all the available funds. Businesses need to reserve cash for contingencies (cash in hand) too.

Other functions

Cash management also includes monitoring the bank accounts, managing electronic banking, pooling and netting of assets, etc. So the cash management for treasury can also be a core function. Although for large corporates this function is managed by softwares, small businesses have to monitor it manually and ensure liquidity at all times.

To add, large businesses have access to credit facilities at competitive rates. For small businesses that access is not available.  Therefore cash management is vital for them. However, even large corporations need to monitor their systems time and again to avoid a situation of bankruptcy.

Phases of Cash and Liquidity Management

The first phase of cash and liquidity management involves maximising liquidity through releasing and centralising cash. The second phase involves maximising the returns on any cash surplus in the concentrated cash pool or minimising the cost of funding any shortfalls. Together, both phases work to increase the profitability of the business.

Releasing Trapped Cash

As the name suggests, trapped cash is simply cash that is trapped in one location and can’t be moved to the centralised treasury. This occurs when there are regulations and constraints which limit cross-border money movement something which is often seen in emerging markets. This blog explains in more detail what these in-country restrictions include.

As we mentioned earlier, the difficult and important job of releasing trapped cash falls to the cash and liquidity management function. Fortunately, there are several methods that can be used to do this intercompany transfers, transfer pricing, and payment of dividends to name a few and companies will typically explore various avenues in their efforts to do this.

Local financial authorities in many countries have banned or blocked the use of these methods, but new techniques are constantly being developed.

Releasing Working Capital

The cash management function is also concerned with releasing working capital which may be tied up in assets like accounts receivables.

In order to do this, they aim to do three things: maximise their DSO (Days Sales Outstanding) and minimise their DIO (Days of Inventory) and DPO (Days Payables Outstanding).

We can use these three factors to determine the DCC (Days Cash Conversion) through a simple calculation:

In other words, the goal is to make payments as late as possible, collect payments as early as possible, and keep inventories as tight as possible.

Seasonality and Working Capital

Seasonality can have a huge effect on working capital. During periods of slow sales, there may be a lesser influx of cash which can affect the amount of working capital a business has available.

Similarly, a seasonal surge in sales requires larger inventory stocks, which must be ordered in advance. The cost of increasing inventory stocks may put additional strain on working capital during periods in which there is less available to them.

To combat the negative effects this can have on the profitability of the business, the cash management function must ensure they have accurate annual cash flow forecasts. They can then use this information to set limits for the amount of cash the business must hold back throughout the year and more effectively manage accounts receivable.

If the cash management function fails to effectively anticipate and prevent a shortfall in working capital, they may fall back on short-term financing options.