Magazine article Government Finance Review

Liquidity Management Made Easy

Magazine article Government Finance Review

Liquidity Management Made Easy

Article excerpt

Managing an organizations liquidity, while a relatively simple function, is crucial to ensuring that taxpayer dollars are properly managed. Improper management can lead to ratings downgrades and higher interest rates on bonds, negative press, and frustrated vendors and employees who receive payments that don't clear the bank. Proper liquidity management, however, allows a government to optimize investment income, avoid overdraft fees, and identify irregularities, errors, or fraud.

Although the terms "liquidity management" and "cash-flow forecasting" are often used interchangeably, they are not synonymous. Instead, they go hand in hand. Proper liquidity management requires a good understanding of the organization's cash-flow needs and requirements, and cash-flow forecasting is the art of successfully estimating the magnitude and timing of the organization's cash inflows and outflows--the foundation for managing liquidity.

CASH-FLOW FORECASTING

Cash-flow forecasting forms the basis for successful liquidity management. The key is to have a comprehensive understanding of all of the sources and uses of the organization's liquidity (e.g., cash).

In its simplest form, a cash-flow forecast is nothing more than a projection of periodic (e.g., daily, weekly, monthly, quarterly) anticipated receipts (i.e., cash inflows) and anticipated disbursements (i.e., cash outflows). The net of the receipts (i.e., total inflows less total outflows) is the estimate of the organization's investible cash balances. A positive number represents the amount of investible funds, and a negative number represents the amount of additional amount of cash needed. In the case of a shortfall, the funds manager would need to liquidate an investment or borrow the cash on a short-term basis.

Creating a cash-flow forecasting model requires answers to three very simple questions:

1. How much cash is available?

2. When will it become available?

3. How long will it be available?

In addition to improving investment earnings and ensuring that sufficient cash available for disbursements like payroll and accounts payable, cash-flow forecasting acts as an early warning system. It can communicate that the organization's cash-flow characteristics are changing, warning the organization about impending budget problems. At the same time, it can enhance interdepartmental cooperation, as the departments are engaged in the process to gain a better understanding of their cash flows, project requirements, and operational needs.

FORMAT AND GRANULARITY

Deciding on the format and frequency that works best for forecasting the organization's cash flows depends not only on the organization's needs, but also on the size of the organization and the volume and complexity of transactions. The format selected should be a rolling forecast that is not restricted to a budget year. The forecast should always look forward for at least one full year. If multiple formats are used (e.g., annual, monthly, weekly, project-based), they must be linked and flow together.

It's a good idea to start with an annual forecast, which estimates the government's cash position in monthly columns to determine the cash available for investments of more than 30 days. The annual forecast provides a clear and easy-to-use monthly overview for investment or decisions about borrowing, and should be prepared for the current fiscal year as well as the next 1 to 3 fiscal years.

For more detail, a monthly forecast can estimate the net cash position in weekly columns to determine the cash available for investments of less than 30 days. The monthly forecast can also be used as a tool to monitor the accuracy of the annual forecast model.

A weekly forecast estimates the cash daily position to determine the cash available for investments of less than seven days. The weekly forecast can also be used to monitor the accuracy of the monthly forecast. …

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