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Home > Cash Flow Management Best Practice > Navigating a Liquidity Crisis Effectively

Cash Flow Management Best Practice

Navigating a Liquidity Crisis Effectively

by Klaus Kremers
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Executive Summary

  • Liquidity crises are usually the symptoms of underlying strategic and operational crises that must be tackled to avoid repeated cash crises.

  • The levers to address liquidity crises are not just operational and financial but also behavioral.

  • 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.

  • Cash constraints can be addressed by collecting and controlling existing cash, reducing net working capital, and restructuring the balance sheet.

  • The control of cash requires very conservative cash authorizations and aggressive control from the financial team on all operations.

  • Reducing net working capital is a well-known source of cash, but requires care to avoid deteriorating relationships with clients or suppliers.

  • 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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Further reading

Books:

  • Blatz, Michael, Karl-J. Kraus, and Sascha Haghani. Corporate Restructuring: Finance in Times of Crisis. New York: Springer, 2006.
  • Graham, Alistair. Cash Flow Forecasting and Liquidity. Chicago, IL: AMACOM, 2001.

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