Why FX & Liquidity Management Are Key In Treasury
19 December 2022 · 3 min read
- What is Liquidity Management?
- The Role of Liquidity Management in Treasury
- Understanding The Treasury Function
- Interplay Between FX and Liquidity Management
- How FX and Liquidity Management Complement Each Other
- Treasury Automation As a Strategic Tool
- Benefits of Liquidity Management
- The Impact of Globalization
In today’s global market, efficient management of foreign exchange (FX) and liquidity is critical for any treasury department. As businesses continue to expand internationally, it becomes increasingly important to navigate the complexities of FX and ensure a robust liquidity management strategy. In this article, we will explore the basics of liquidity management, discuss the interplay between FX and liquidity management, and look at the benefits of efficient liquidity management.
What is Liquidity Management?
Liquidity management enables finance teams to have a holistic view of their financial resources and improve their cash flow margins. This presents a strategic opportunity for Treasury to have a system in place that helps the CFO to be more agile and have more control of the company’s liquidity risk.
The Role of Liquidity Management in Treasury
Treasury departments are responsible for ensuring that the organization has enough liquidity to meet its short-term obligations while minimizing idle cash. By efficiently managing liquidity, treasury professionals can maximize returns on the company’s cash holdings and maintain financial stability.
Effective liquidity management requires a deep understanding of the company’s cash flows, an accurate forecasting process, and the ability to respond swiftly to changes in market conditions.
The treasury department acts as the custodian of the company’s financial resources, safeguarding and optimizing its cash and financial assets. It liaises with various internal stakeholders, including finance, accounting, and operations, to ensure that financial goals align with business objectives.
One of the key responsibilities of the treasury department is currency management. This involves monitoring cash flows, forecasting liquidity needs, and optimizing cash utilization.
FX and liquidity management are closely intertwined. Treasury professionals need to understand this intrinsic connection to develop comprehensive strategies that address both FX and liquidity risks.
How FX and Liquidity Management Complement Each Other
Effective liquidity management is essential for managing foreign exchange risk. A company with limited liquidity may find it challenging to navigate currency fluctuations and settle obligations in different currencies. Conversely, FX risk management is crucial in maintaining sufficient liquidity, as unexpected currency movements can have a significant impact on cash flows.
By carefully balancing FX and liquidity management, treasury professionals can ensure that the organization can meet its financial obligations while protecting its financial position.
In currency risk management, swap execution is the process of adjusting the firm’s hedging position to the cash settlement of its underlying FX exposure. At first sight, it looks like something best left to the technical expertise of the Treasury team. But could swap execution be the stepping stone for a more strategic view of Treasury operations, one that raises the profile of treasurers and improves communication with the C-suite?
We’ve seen finance teams shying away from using more currencies in their business partly because of the complexities involved in manually executing the required swap transactions.
Faced with poor traceability and a series of operational risks, many treasurers dread this time-consuming and error-prone activity. Yet, thanks to swap automation —a solution embedded in Currency Management Automation software—, FX management becomes a less resource-intensive undertaking than previously thought.
This makes it easier for the finance team to allow the use of more currencies in the business. And here’s the key part: using more currencies, in turn, can spark a number of liquidity management-related benefits.
- Selling in more currencies. As customers pay in their own currency, the risk in accounts receivables is lowered.
- Buying in more currencies. As more currencies are used, suppliers who get paid in their own currency may grant extended payment terms.
- Managing currency risk.
As FX hedging is undertaken, automation allows managers to delay hedge execution, leading to:
- More time for the treasury team to update cash flow forecasts
- Less cash immediately disbursed for collateral requirements
- More netting opportunities and less trading costs
All of this can incite finance teams to take currencies for what they truly are: a strategic opportunity to enhance the value of the business. As more currencies are used, the need for FX automation grows, further adding to the benefits. Now that’s the definition of a virtuous loop!
The Impact of Globalization
The global marketplace continues to expand, with businesses increasingly conducting operations in multiple countries. This trend necessitates a comprehensive approach to liquidity risk management.
FX and liquidity management are key components of effective currency management. By understanding the significance of FX, treasury professionals can optimise their financial operations and navigate the complexities of the global marketplace.
Embracing technological innovations and staying attuned to future trends will enable treasury departments to adapt to changing dynamics and deliver value to their organizations in an increasingly interconnected world.