In the current economic environment and the volatility that we’re seeing in European markets, the importance of understanding liquidity options, and creating and managing a liquidity strategy to maintain the health of the business, cannot be overstressed. Lloyds Bank Commercial Banking Director of Specialist Banking, Robert Hare, considers the options.

Why would a business need a formal strategy for liquidity and what role does the banker play in its formulation?

We live in a world of uncertainty so it’s important that all businesses manage risk. Managing liquidity is an example of risk mitigation and companies that have taken the right steps should be able to protect themselves from surprises. They also need to be prepared for opportunities in the market. In order to fulfil both of these requirements, they have to know their overall business strategy and be able to apply it to make best use of their business assets – and cash is certainly one of them. A formal strategy for liquidity must therefore sit within the overall business strategy, directing the use of that cash. Many corporates have been concentrating on two things over the past 12 months: cutting costs and keeping cash. But the more they do that, the more imperative it is that they have a strategy for that cash. When it comes to forming liquidity strategy, global corporates and mid-cap firms are now realising that because of economic uncertainty they need to start looking at their cash balances through a different lens. And that’s where bankers come in.

What informs today’s corporate approach to liquidity – is it all about risk mitigation or is there more to it?

As Europe continued (and some may say continues) to implode, the concentration has been on the return of cash. But as things settle down, thoughts start to focus on the return on cash and what sort of yield it is going to get. However, in addition to protection or yield discussions, it is also about the effective use of the different types of cash a business has. Many will have a strategic cash pile, where they are looking for large projects and opportunities to acquire or to make investments. But there are other elements at work here, including a necessity to place a really keen lens on the working trade cycle of the business – especially working capital – to make sure that they are optimising that cycle, and thus their use of cash, by getting money from debtors when they expect to get it, and by making sure that they’re not paying on invoices too quickly. These decisions will all be driven by the cash strategy.

What are the dangers of not forming a liquidity strategy?

For a business, looking at its cash and liquidity strategy is like looking at its raw materials and production strategy. If either gets out of kilter with opportunities and with the operation of the business, it can cause serious difficulties. Cash has always been the lifeblood of a business, so it has always been important. The liquidity strategy must cover the immediate, the short-term and the longer-term needs of the business. The role of the treasurer or cash manager is to make sure that they have the right quality and quantity of funds available at the different points in time of the business lifecycle so they can meet any threats and take advantage of any opportunities that come along.

Forming a liquidity strategy is just as important for a small business as it is for a large business. Obviously it becomes more complex for the latter as they start looking at international sweeping and pooling, making decisions whether to centralise or de-centralise their cash pools, ensuring the correct reporting processes are in place in a de-centralised model or, if centralised, that the exact levels of cash are left in country for day-to-day requirements. Despite these variants, the essentials remain the same: you have to have the right level of cash at the right time. A well-formed liquidity policy helps to ensure that.

What can Lloyds Bank offer clients to help them form and manage an effective liquidity policy?

Liquidity is very much on the agenda now, but over the past nine months or so we have found, surprisingly, that many corporates don’t have a robust treasury policy to tackle it. As their banker, we’ve been talking with them to get feedback in terms of their critical needs and requirements and then helping them to shape what a liquidity policy should look like. We’re able to go to our clients – whether they’re a university, a government body or a corporate – and advise them on the areas that they should be looking at to help them formulate an effective liquidity policy. There will be elements pertinent to each business and to each sector but, as I said before, the principles remain the same. So, for example, it’s about currency and it’s about the extent to which they tie up cash. It’s about their liquidity buffer and the extent to which the business needs a pool of cash, what that pool might look like, where it needs to be, and how quickly they need to access it.

In terms of technology, one of the solutions Lloyds Bank has is a software product called Optimiser. This enables us to sit down with treasurers and CFOs and help them go through their past, present and future cash requirements, building as we go as complete a picture as possible of what they need from their cash and how they can achieve it.

Typically, we’ll go back a year or two and talk about how they have used their cash and cash sources, what trends they may have seen and what the current year looks like in relation to previous years. We can then talk about a range of aspects going forward, such as what is anticipated, whether a greater buffer may be needed for cash access, what the residual funds are and how best to invest any surplus.

How open are businesses to advice from a bank?

In discussing these matters with clients we do find them immensely receptive. No one can definitively claim to have the answer to Europe’s problems – and there are many people who don’t even understand some of the questions because the landscape keeps changing. What we have found with all this uncertainty is that corporates want a trusted advisor, someone who is seeing the same sort of things that they are, but from a different perspective. The role of the banker is therefore paramount, drawing on our experience, sharing that with clients and helping them to try and look around corners at what might be coming along next. As I said, no one has all the answers, but we can help treasurers ensure they have the right level of flexibility around their business model and around their cash, so that they can optimise their response.

How important is it to review policy regularly and which points of reference should be used?

It’s not only ‘how often’, but it’s also ‘how to’. Policy review should extend from the day-to-day process of looking at and understanding what’s happening in the financial markets, to a formal consideration of whether the current liquidity policy is appropriate for the coming 12 months. In these more turbulent times I’d suggest a thorough evaluation at least quarterly to assess what they are seeing and what has changed in their own business, in the market, and in the particular banks they are dealing with. Then they can make a judgement as to whether the current liquidity policy is sufficient to meet requirements over the next three and six month periods and make changes as appropriate.

As for ‘how to’, undeniably there is still some concern about bank risk, so we want our clients to consider how they wish to evaluate the risk they are taking on, vis-à-vis leaving funds with banks. Some of the credit ratings agencies are still receiving criticism for their ratings dating back to the start of the 2008 crisis. They have a long road to travel to recover their reputation, but it has forced corporates, and certainly banks to encourage corporates, to evaluate the risks they are taking through different – and more dynamic – media. We say certainly look at credit default swap (CDS) ratings, and I’d add that bank share price is a major tell-tale sign too; if there’s a material movement in that, you’d really want to know why. There also needs to be an appreciation of possible impact in terms of the wider market, so do investigate what the exposures are of certain banks to different parts of the world. In essence, make sure your radar is always switched on!