Staying Liquid

Staying Liquid

Knowing how much cash reserves your company needs to maintain is tricky, but balance is key according to Mohammad al-Karaki, partner at Ernst and Young Jordan.

By Rebecca Irvine

Cash reserves are a company resource like any other, and should be treated as such. Maintaining the appropriate level requires an acute awareness of the company’s business model, function, and forecasts.

But while it’s important to have a firm grip on your company’s cash, it’s equally important not err on the side of caution to a detrimental degree. Afterall, having too much money in liquid assets can be equally damaging to your company as having not enough money available when you really need it.

Mohammad al-Karaki of Ernst and Young said there isn’t a one-size-fits-all approach to managing cash reserves. It all depends on the type of business, industry, customer base, and stakeholders involved. Banks, for instance, a high degree of liquidity is a must to ensure deposit demands can be met. But for other businesses, it’s not so important that the percentage be high.

Al-Karaki cites the example of a large retail business that currently has liquid assets of around 65 percent. “That’s not an efficient employment of funds,” he said, with “over-liquidity” of this nature failing to utilize resources properly since returns on deposits are currently 3 percent or less. It’s important therefore to keep in mind your company’s circumstances, and if the demands on your deposits are on the lower side, consider investing your resources in more effective ways.

If being too cautious is a no-no, how exactly should you arrive at the appropriate measure for your business? Attention to detail and planning is absolutely integral to success in this part of your business, al-Karaki says. Treasury functions within a company need to monitor cash flows on a weekly or monthly basis, and ensure that further capital is raised if needed. Beyond this, looking forward on a yearly schedule, companies should be planning the future budgets continually.

While smaller companies and startups may not have the human resources to dedicate many individuals to these calculations, they should equally be careful not to overlook these decisions, al-Karaki warned. Many potentially successful startup projects have been casualties of poor financial planning, proving that however good your idea is, cash flow is vital. If entrepreneurs are less versed in the intricacies of these decisions, angel investors are often able to provide guidance and support in this regard, so if that sounds like you, be sure to choose helpful mentors.

Why is this all so important? Beside the obvious reasons why having cash available is necessary, the damage to reputation is a big consideration to bear in mind. Defaulting on payments may be an issue that can be overcome if one customer out of 1,000 is affected, but if an influential stakeholder is impacted, your company could suffer huge losses as consequence. It may seem a simple point, but the notable example of Sameh Mall’s losses after not meeting payments to suppliers is a real-life warning. “Business is all built around trust,” al-Karaki explained, and if this is broken then the damage can be irreparable.

Unfortunately, there is no golden rule or specific percentage that your company should maintain its liquidity at. Al-Karaki said current ratios and quick rations between assets and liabilities can offer useful benchmarks. Maintaining these above 1.5 and 1 respectively should mean that your company is keeping enough cash assets where needed.

Managing your business’s specific circumstances and ensuring you know that you have the right amount of funds in assets is what’s most important. Trying to maintain an arbitrary cushion of cash in the bank for the sake of comfort is likely to be under-utilizing one of your most important resources. Above all though, he stressed that a balance should be aimed for. “Liquidity should be balanced. You shouldn’t be short but you shouldn’t be under either,” he said. In this case, putting the hours in, and asking for assistance when you need it, definitely will pay off.