Executive Summary
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Liquidity crises are usually the symptoms of underlying strategic and operational crises that must be tackled to avoid repeated cash crises.
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The levers to address liquidity crises are not just operational and financial but also behavioral.
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CFOs must recognise the liquidity crisis and communicate openly to crucial stakeholders as a first step; they need to build trust with current and new financing stakeholders by producing a predictable rolling liquidity forecast.
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Cash constraints can be addressed by collecting and controlling existing cash, reducing net working capital, and restructuring the balance sheet.
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The control of cash requires very conservative cash authorizations and aggressive control from the financial team on all operations.
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Reducing net working capital is a well-known source of cash, but requires care to avoid deteriorating relationships with clients or suppliers.
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Restructuring the balance sheet is a medium/long-term solution. It mainly involves selling assets and raising/refinancing debt and/or equity.
Introduction
Until 2007, debt had become very cheap and accessible. Most companies sharply increased their leverage. In Germany, for example, the net-debt-to-EBITDA ratio extremes moved from around 3 in 2002 to around 7 in early 2008. However, a downturn in company performance or an external financial crisis—where lending becomes scarce and borrowing expensive—can make this approach risky.
What Is a Liquidity Crisis?
A company’s liquidity is its ability to quickly pay off its short-term debts as they fall due, and still have enough cash to keep operating. Liquidity crises can be broadly split into company-specific crises, and those driven by external factors—by market or general economic changes. In both cases, the company experiences a loss of investor confidence, making it difficult to raise further cash. If the company has insufficient cash reserves, it can very quickly run into serious difficulty. A familiar vicious circle takes hold, where a company cannot pay its debts because it has no funds, but cannot raise funds as its financial difficulties result in the downgrading of its debt.
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