Liquidity Management: Why Is It Important?

Efficient liquidity management ensures you have adequate cash to cover your expenses. When practiced effectively, it can help a business manage its finances such that all expenses are covered by the available cash reserves. Liquidity management is necessary to allow businesses to function smoothly, including discharging financial responsibilities in a timely manner.

In the absence of a sound liquidity management program, the business may operate within what could be a false sense of financial security. Cash balances may appear inflated, leading to situations where financial resources are actually depleted without it being apparent. In case of reduced cash stores, businesses may continue to operate in the knowledge that they have adequate money, until an unexpected emergency or requirement surfaces.

Cash emergencies can take up different forms; right from loss of revenue in the form of a key client or a good investment opportunity for the business, or simply an unseen expense. Without liquidity management, it is easy to slip into a state of unawareness. However, this can spell bad news for the business. Payments not honored or checks that bounce can create a negative image for the business; they can also shake up investor trust.

Poor management of cash or liquidity can also hamper operations. Salaries can get impacted, plans for growth and expansion may face suspension and the business may lose out on good opportunities. The other important aspect of sound liquidity management is to ensure that there is a cash reserve for the business at all times. Usually, everyday income does not match up to the expenses incurred by the business. For this reason, cash flow needs to be managed carefully to ensure that expenses do not exceed cash reserves.