A comprehensive guide to liquidity planning

Liquidity planning is all about ensuring that you have the funds you require at the moment, whether it's to meet your essential everyday costs, cover an unexpected occasion, or take advantage of possibilities you don't want to pass up.

Cam McIntyre

Liquidity planning is all about ensuring that you have the funds you require at the moment, whether it's to meet your essential everyday costs, cover an unexpected occasion, or take advantage of possibilities you don't want to pass up.

What Is a Liquidity Gap?

Liquid assets are assets that are easily converted to cash. They're also referred to as "quick assets." Cash, marketable securities and accounts receivable from customers are examples of liquid assets. Liabilities are obligations a company or individual has the responsibility to repay within one year's time. Accounts payable, such as bills.

A liquidity gap is the difference between a person or entity's total liquid assets and the total amount of liabilities assumed by that individual or company. It is one way to quantify a person's or organization's degree of financial risk. A liquidity gap can be measured in a number of ways, including by comparing change in the liquidity gap at two or more points in time. An organization may also select to assess its financial health by measuring its own liquidity to asses its financial health.

Whether the difference being assessed is for a person's or an organization's money, the fundamental technique of calculating it is the same. The equation includes the amount of liquid assets held by the individual or company, such as bank accounts, minus any obligations incurred by them. A negative gap or marginal gap means that the individual or organization is losing more money than it takes in. When the difference is positive, the person or organization has liquid assets left over after paying off all of its obligations.

How to Master Liquidity Planning:

Understand where every penny is coming from:

Do you have sufficient funds? This requires an in-depth knowledge of your sources of revenue. A monthly salary or pension is typical, yet you might have dividends, bond interest, capital gains, rental properties, employee participation plans, stock options or fixed-term deposits as well. Make a comprehensive list of all your income sources.

Understand the liquidity of each of your business asset:

The next stage is to categorize each income stream's liquidity, which we'll refer to as assets. Assess the process, ease, and cost of liquidating each asset. Is direct online settlement possible or do you require a co-signatory at the bank? Check if any assets may be utilized as collateral to borrow liquidity quickly and economically.

Be aware how much you need to spend

Now is the time to assess your spending requirements. It's useful to think long term and anticipate education costs, renovations, or travel. This is where a liquidity plan comes in: A liquidity plan depicts income and spending streams over time, allowing you to spot surplus liquidity for saving or investment purposes, as well as liquidity gaps that need coverage from liquidity reserves.

Define the essential liquidity requirements

Essential liquidity, precautionary liquidity, and discretionary liquidity are three types of liquidity that may be distinguished. You should definitely have an excellent knowledge of your essential financial requirements: those which address your basic living expenses such as rent or mortgage payments, insurance, food, transportation, and clothing. This money must be accessible to you as soon as possible at a low point.

Create a precautionary liquidity plan

Unanticipated events and circumstances do happen. It's a must to plan for precautionary liquidity, especially if you lose your job or face medical expenses or the death of a loved one. Talking to an expert may help you figure out how much cash you'll need on hand in case of an emergency. Assets should be accessible with minimal expenditure of time.

Make sure you know how to access discretionary liquidity

As a risk management instrument, sound liquidity planning should allow you to take advantage of excellent possibilities, such as real estate or financial investments. This is where discretion comes in. You may be able to catch opportunities that you don't want to miss if you have quick and uninterrupted access to these assets.

Have an accurate plan for the liquidity gaps

Accurate planning reduces the chance of having to sell assets at an unfavourable market or with a severe cost penalty. Consider longer-term financial objectives or projects that require liquidity, such as renovations or bequests to children. Detailed planning aids in the identification of incoming liquidity events like as pension assets, company equity plans, insurance policies, and inheritance.

Balance your liquid assets allocation and your risk profile

You've now completed a wealth overview and assessed your liquidity requirements. The next step is to choose the proper asset allocation strategy, which is best achieved by managing your assets so that they produce more income. You're better equipped to determine your risk tolerance and know how much and what kind of risk you can take if you've done your liquidity planning correctly.

Why is liquidity planning crucial?

With many individuals facing economic uncertainty and financial strain, it's a good idea to review the security and financial stability of your income streams. Examine your spending if your revenue has changed: Are all direct debits, standing orders, and regular monthly payouts still required? This is another good reminder to diversify your portfolio geographically as well as asset class. It's a timely reminder to diversify your portfolio by geography and asset class. Consider whether temporary financing options such as Lombard lending or liquid assets are appropriate for those that need more money.

Keep planning and carry on planning

The ability to think ahead and anticipate future liquidity needs may prevent uncomfortable and challenging situations from becoming emotionally overwhelming. Planning for both the best- and worst-case scenarios ensures that, if unpleasant circumstances arise, at least your finances will remain as tranquil as possible.

Different types of liquidity planning:

Integrated liquidity planning

The integrated liquidity planning process begins with anticipated liquidity-pertinent events, which are based on the controlling stage of the managing. That is, controllers provide projections and assumptions derived from control processes, such as expected future growth. Effects are manually altered, such as with database normalization. Integrated planning utilizes the direct approach methodically, but it is based on results-based financial planning. The goal is to minimize mistakes from the straight actual cash flows statement while also eliminating manual planning activities. This alignment occurs as a result of the joint responsibility for financial planning (controlling) and cash flow planning (treasury). Processes may be aligned in terms of frequency, planning horizon, and time slices if they are properly planned.

The software is made up of two parts: a firm's business plan on the one hand, and accounts payable (AP) and accounts receivables (AR) data. The days of sales outstanding and days payable outstanding are calculated utilizing previous AP/AR data. They allow the empirical establishment of the approximate arrears between income-effective bookings and payments. The business and treasury planning are distinct from one another, so there's a single version (most likely) or several different versions for each. As a result, incoming and outgoing transaction data is classified dependent on the company plan. To achieve the greatest possible correlation between business and liquidity planning, appointments for financial and non-financial planning are aligned with one another (at the level of categories).

Predictive cash forecasting

Predictive cash forecasting is the practice of predicting future values using statistical regression methods to compute a projection of historical data. In contrast to other planning techniques, which are based more on business instinct, predictive analytics approaches produce a data-driven analysis of internal and external influences. The cash flow model learns about the various variables and their influences on past cash flows as a result of this process. The model adjusts its parameters by comparing them to actual data with the least variation between prediction and reality. As a result, the model is able to forecast future cash flows. If the conditions of the influencing variables change, the model must be updated. Interdependencies in financial forecast accuracy can now be incorporated into the data model and instantly produced planning information as a result of these complex interactions.

The following are the steps involved in determining a break-even point using a specific method: A framework especially created for this is used to project a monthly cash flow based on historical data. The various models (such as ARIMA, Add. Regression, and others) are developed and improved via automatic parameter selection.The integration of forecasts' frequencies is also crucial for risk assessment. The predictive analytics approach provides additional choices such as the automatic selection of the optimum data granularity and the breaking down of time series into seasonality, trends, and other units. The last stage in the model is the quantitative evaluation, which uses precisely defined error metrics (such as MAE and SMAPE).

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