5 need-to-know liquidity management tools

The world of treasury, and liquidity management in particular, is an often unexplored area of banking. Even many of us who work at a bank, in finance, or FinTech, know little about liquidity management and the crucial role it plays in global finance and cash management. For this exact reason, we have decided to create a list of some of the liquidity management tools every person in finance and banking must know.

What is liquidity?

Liquidity refers to the ease in which an asset can be converted into cash without affecting its market value. Therefore, cash is the most ‘liquid’ trading tool. However, if you were to owe a debt, and your only valuable asset was a rare coin worth $10k, its liquidity would be determined by how quickly you could trade it for the equivalent value in cash. As there are many coin collectors, you could likely shop around and find someone willing to pay approximately $10k, however, if you needed the money tomorrow, you may need to sell it at a discount. In comparison, if you owned $10k worth of Microsoft stock, you’d likely be able to sell it for $10k at any given moment today. This is why investment assets, such as stocks and bonds, are typically thought to be the most liquid non-cash asset.

When assessing the health of a company or bank, liquidity helps investors determine whether a firm is able to pay its short term debts and current liabilities.

What is liquidity management?

Liquidity management refers to a set of processes, strategies, and supporting mechanisms/tools that ensure a business or bank is able to access cash when and where it is needed. This cash could be used to pay for goods and services, payroll, debt repayment, or new investment opportunities. Liquidity management is fundamental to enabling large businesses and banks to manage their global operations, but on a smaller scale, can also be crucial in helping growing regional companies and banks operate and expand.

Need-to-know liquidity management tools

• In-house bank (IHB): This is a form of financing that uses the company’s own cash to provide a range of treasury and liquidity services typically provided by a bank. This could include lending and foreign exchange, but may also include payables on behalf of (POBO) and collections on behalf of (COBO) in a range of currencies. In-house banking is a very expensive function to implement, so it is only used by very large, typically global corporates. However, there are new solutions on the market that can be used as a cheaper alternative to some in-house banking functions.
• Notional pooling: An arrangement whereby a bank will take the net of their corporate client’s account balances (pooling the balances ‘notionally’, or in theory) reducing the interest spread charged by the bank on overdrawn accounts. While savings accounts will typically pay a small amount of interest to the account holder, the interest paid to the bank due to overdraft charges will certainly be higher, making it advantageous for large corporate clients to take advantage of notional pooling.
• Sweeping: ‘Sweeping’ is a mechanism by which large organizations can make a predetermined transfer across many accounts into one account (or one to many). Typically companies sweep money from their ‘child’ or subsidiary accounts into one parent account, which centralizes cash and makes it easier to pay off debts and invest excess cash. Sweeping can also be used to top-up accounts that do not have enough funds at the end of the day. To learn more about sweeping, check out this informative article.
• Virtual Accounts: Virtual accounts are used by large corporates to simplify their payment reconciliation process and can significantly reduce costs, time, and errors incurred by the receivables team. Virtual accounts are essentially reference numbers issued by a bank on behalf of their corporate clients. These virtual accounts appear to be real bank accounts and are recognized by clearing and settlement systems, but funnel funds back into one physical account. This simple, but useful tool differentiates each payment and their source so that companies that work with thousands of partners do not have to sift through thousands of invoices.
• Virtual Account Management (VAM) Solution: A VAM solution is the new generation of Virtual Account tools. While they can do everything a virtual account can do, they do a whole lot more. VAM solutions are not simply reference numbers used to facilitate a more efficient reconciliation process, they can also be used to manage global liquidity, providing visibility of all intercompany accounts around the world. Corporates can create idealized virtual account hierarchies and close the majority of their physical accounts, execute intercompany transactions, setup sweeps, and reduce their reliance on notional pooling. It is a game changer in the cash and liquidity management space and the first giant technological leap that the industry has seen in some time.

Did we miss anything you think should be included in our article? Leave a comment and let us know! We can always expand the article for those interested.