Market-based approaches to cash management and liquidity

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Cash management
Treasurers Handbook
Andrew Burns

Director of Business Development,



The traditional sources of liquidity can no longer be relied upon to provide adequate working capital for businesses. However, technological advances and innovations designed to solve liquidity problems are gaining momentum. As more and more forward-looking firms step up to put these new practices into place, it’s possible to foresee a future where this technology becomes the standard.

Fundamental economic changes require new solutions

The credit crisis severely impacted the global economy, which has been trying to recover ever since. Although progress has been made, there are fundamental inconsistencies that are hampering a strong recovery. On one hand, stock market growth has been significant, businesses have record amounts of cash on their balance sheets and banks have reduced the risk they carry while ensuring access to liquidity. On the other hand, Small and Medium-Sized Enterprises (SMEs) are still finding it difficult, if not impossible, to get access to the liquidity they need. Because SMEs represent a significant percentage of global GDP, they are vital to the health of the economy and their struggles impede economic growth.

Liquidity excesses and shortages

While many businesses have too little access to liquidity, others have access to significant levels of cheap liquidity. When you have large companies sitting on cash reserve stockpiles earning next to zero interest and small companies unable to affordably access the funding they need, it affects entire economies.

Various regulations designed to alleviate this problem have often unintentionally served to exacerbate it. For example, Basel III requires banks to de-risk their balance sheets by carrying adequate liquidity to cover their liabilities, should another financial crisis should occur. It is intended to strengthen economies and make them more resilient in the face of economic catastrophe. However, the consequences of de-risking have fallen disproportionately on SMEs. Because they represent a greater risk than larger firms, lending to SMEs has dropped by half since 2008. Thus, the most cash-starved businesses have lost another tool that would previously have provided them with some of the working capital they needed.

The second credit crisis: traditional liquidity solutions fall short

Particularly in Europe, banks provide the majority of business funding. Even in the US, limits on access to business loans can chill economic growth and lengthen recovery from downturns. Although SMBs in the US have more sources of alternative funding available to them than their European counterparts, it is not enough to make up for the high cost or unavailability of bank lending.

US and UK central banks have introduced Quantitative Easing programmes to add liquidity to commercial banks by purchasing their assets in the hope that it will free up additional liquidity for SMEs. Unfortunately, this has not trickled down to the SMEs.

Alternative liquidity solutions

Banks were the first to provide solutions to treasurers with excess liquidity who are seeking alternatives to putting cash on deposit, or into money market funds that still allow them to maximise return, maintain desired levels of liquidity and manage risk. SMEs with limited liquidity look for affordable ways to smooth out their cash flow and gain liquidity as needed.

Banks have increasingly been offering reverse factoring as a solution, accelerating accounts payable from a buyer to a supplier in return for a discount, based on the buyer’s credit rating. On the surface, this appears to be a good way to funnel much-needed cash to suppliers who are looking for affordable ways to smooth out their cash flow and gain liquidity as needed. But ultimately it is solving a different problem: delivering a better-looking balance sheet. Buyers get an increase in cash due to the extended terms of the programme, thereby creating a healthy cash flow. Suppliers do get early access to the cash flow they need. However, most companies offer reverse factoring to only a small percentage of their biggest or most important suppliers. Most of these select suppliers already have better access to liquidity than smaller SMEs, and the rest are left with lengthy payment cycles that leave them with even less cash flow. Lastly, unless the corporate recognises the programme as debt on their books, the bank’s P&L will benefit from the discounts, and not the corporate.

Despite these alternative options, corporates still have short-term cash earning little or no interest and SMEs are still in need of cheaper sources of liquidity.

Freeing trapped cash

A confluence of factors is changing the way a growing number of corporates are managing their liquidity. Slow economic growth has triggered the need for corporates to engage in cost reduction programs to ensure their margins are maintained, bringing a greater focus on P&L. The low-interest rate environment has challenged treasurers to find low-risk investments that produce higher returns to offset the inefficiency of short-term cash. Decreased lending and increased payment terms have squeezed suppliers to such an extent that they have become a greater risk of supply-chain disruption to the buyers.

Some corporates have now realised that by taking some of their cash and offering it to their suppliers in return for a discount means solving all these problems in one go. Payment acceleration can be a good solution, but it can only be successful under a particular set of circumstances. One of the keys is maximising supplier participation, both in the number of suppliers using a given program and their frequency of use. Another important aspect is consensus between the buyer and supplier regarding the discount return that is acceptable to both. The discount needs to be both competitive with other lending costs for suppliers yet also improve gross margins for the buyers.

So as long as corporates can generate a reasonable yield on their short-term cash, the idea of a dynamic discounting/payment acceleration programme makes good financial sense. Plus, there is no risk, since only approved invoices are paid early, the corporate benefits from the discount by reducing costs and improving gross margins and EBITDA, higher effective returns on cash are generated and the supply chain is strengthened (and de-risked) from a financial perspective.

The SMEs gain by accessing liquidity at rates lower than their borrowing options (assuming they have borrowing options at all). As they increase working capital, it gives them the opportunity to put money back into their operations, become more profitable and, ultimately, expand. Not only does this benefit the supplier-side SMEs, but it has a positive effect on the economy as a whole.

Technology makes it possible

Dynamic discounting has been around for a number of years based on the legacy banking approach of the buyer determining what rate the suppliers should pay for accelerated payment of invoices. This approach, although positive, is limiting. How can the buyer know the liquidity needs of their suppliers at any one point in time? How can the buyer know the alternative cost of financing for their suppliers, to make sure the rate they’re offering is attractive? These inefficiencies take their toll on the success of the model both from a buyer and a supplier perspective.

The evolution of dynamic discounting has meant that true dynamic discounting now relies on a marketplace with objective supply and demand dynamics removing those inefficiencies to maximise benefits for both the buyer and the supplier. This type of exchange first gained popularity among firms that were already looking for technology solutions to move their businesses forward, including Costco Wholesale, and other innovative companies.

As you can see from Figure 1, there is a progression related to accounts payable handling that offers far more options as technology takes off:

C2FO Figure 1 .jpg

The network effect of a market-based model results in many companies finding that their suppliers are already participating when they join, which accelerates the benefits for all parties.


Marketplace-based supply chain liquidity management can be the best way of helping businesses maximise the value of their short-term cash while providing liquidity to their supply chain.

For companies in the middle of the supply chain who are both buyers and suppliers, cash management is a constant challenge, and accounts receivable can be an inexpensive source of liquidity when and where it is needed.

Cash excess is a risk and it is difficult to maximise return in the short term, without increasing risk. With a marketplace-based payment acceleration programme, there is opportunity for significantly higher returns that impact EBITDA, thereby turning treasury from a cost centre into a value centre.