Lecture 5: Cash Flow and Liquidity Management I

Part 1: The Concept of Liquidity

  1. What is liquidity (PPT 4 - 6)
  1. Drags and pulls on liquidity

The reasons of a company having negative cumulative CFs: seasonal CFs

Liquidity shortfalls

drags on liquidity are forces that delay the collection of cash: slow down cash inflow

Pulls on liquidity are decisions that result in paying cash too soon: accelerate cash outflow

Liquidity risk is not simply cash management risk (CMR), as it is more extensive that just managing the cash function, CMR is just one element of liquidity risk

  1. Asset side liquidity (market or transactional liquidity)

what is market liquidity risk

  1. When sell, the price has dropped, prices can move adversely through the actions of buying and selling
  1. There are no willing buyers (equity in a joint venture that is failing)
  1. Also include the variability in the assets that are being used as collateral

different proxies of liquidity in markets with market tightness and depth consideration (PPT 11)

Bid-ask spread

Volume

  1. Liability-side liquidity (balance sheet or funding liquidity)

Definition: PPT 12

"At-risk" facilities (PPT 13)

Liquidity risk spiral (PPT 15)

  1. A simple perspective of liquidity risk: liquidity shortfalls arise from short-term balance sheet items (PPT 16)
  1. Cash inflows and outflows (PPT 17 - 18)

Part 2: Wording Capital and Cash Conversion

  1. Working capital V.S. Cash conversion (PPT 20 -21)

Measuring the cash conversion cycle

Managing the cash conversion cycle (PPT 24 - 25)

Work-in-process/Inventory period

Accounts payable period

Accounts receivable period

Cash collection example and CCC by industry

  1. Sources of corporate liquidity risk (PPT 28)

2.1 Sources of asset-side liquidity

short term liquid assets (Sources of funding)

Cash

Marketable securities

AR, either through outright sale or pledge of unencumbered receivables

Inventory through outright sale or pledge of unencumbered inventory

Long term fixed assets

leasing agreement

Repurchase agreeements

Asset-side liquidity risk problems (PPT 31)

2.2 Sources of liability side liquidity

Short term (PPT 32)

Long term (PPT 33)

Other sources of liquidity (PPT 34)

Liability liquidity risk problems (PPT 35)

  1. Liquidity risk in banks (PPT 36)

Sources of liquidity risk in banks (PPT 37)

Asset side

Liability side

Contingent sources

Drivers of liquidity risk in banks (PPT 39)

Part 3: Northern Rock Bank case study

funding long-term mortgage assets (both prime and subprime) with short-term funds, significant reliance on volatile, short-term, wholesale funding

A risky business model: requires a liquid and well-bid securitization market

excessive concentration in risky, correlated securities (securitized home mortgage) that were ultimately illiquid and could only be liquidation at a fraction of their stated value

lack of alternative funding sources for emergency draw-down

lack of contingency funding plan