23 April 1985 Corporate management of liquidity problems studied

Measures used to resolve corporate liquidity problems are quite varied and often ineffectual, according to Professor Roger Juchau, Professor of Finance and Accounting at Canterbury's Lincoln College, who this month reported on a survey carried out in Australia on how top Australian corporations coped with these problems.

Australian Roger Juchau took up the post of Foundation Professor of Finance and Accounting at Lincoln College earlier this year.

He came from the Nepean College of Advanced Education School of Business where ,he headed the finance and information systems division for 10 years.

Two years ago, Professor Juchau and two colleagues, Jack Flanagan and William Stewart, both School of Business lecturers, felt not enough was known about how corporate management handled liquidity problems.

"Everyone in business knew about liquidity problems, but there was no empirical data on how corporations identified and resolved these problems," Professor Juchau said.

So the three began a survey to find the opinions on liquidity management of finance directors in Australian corporations.

They chose the period from 1981 to 1983 - a time when recession in the Australian economy developed fairly rapidly.

Their survey followed a survey undertaken in the United States in 1980 and 1982, which examined liquidity experienced by major U.S. companies
in the late 1970s.

Both surveys looked at the objectives of liquidity management and factors to be considered in managing liquidity. 

Professor Juchau said he felt that a similar survey in New Zealand would result in findings very like those in the Australian and U.S. suryeys.

"There were differences in ranking order of importance for factors relating to liquidity between the U.S. and Australian surveys," he said.

"And chances are that there would be differences between any New Zealand survey and the Australian survey."

In both the Australian and U.S. surveys the most important factor in liquidity planning and management was seen as cash flow projections of up to a year.

The Australians ranked timely, accurate management reporting second, and projected earnings fourth as important planning and management factors.

Those surveyed in the United States put management reporting sixth, and projected earnings eighth.

Build up of inventory was seen by both Australian and American managers as being most important in alerting a corporation to identify liquidity problems.

But the Australians saw an increase in debt ratio as being equally important.

Both groups saw inventory, sales and cash variations as signalling problems.

Most important for managers in both countries was to reduce investment in inventories to deal with liquidity problems.

Freezing new hirings and laying off personnel were seen as slightly more important in Australia than in the United States.

Also, the Australians gave just a little more emphasis to greater cost control of overhead spending, although the Americans saw this as being nearly as important.

The Americans headed the Australians in how important they regarded trimming receivables, increasing short-term borrowing, educating non-financial personnel on the significance of managing their assets, and disposing of assets not meeting long-term profit objectives.

Professor Juchau said better understanding of corporate liquidity management was "absolutely imperative in New Zealand."

New raisings of capital should be for expansion, and not used to get out of existing workng capital difficulties, he said.

"The name of the game is pro-active, rather than reactive liquidity management"

Professor Juchau said that one aim of the survey he and his colleagues carried out in Australia was to provide a check-list for corporations to review liquidity management.

"There is a widespread view that in the drive for profitability corporations have lost sight of the need for maintaining liquidity," he said.

"Profitable operations do not guarantee positive cash flow, and operations providing cash flow do not necessarily generate profits."

Attention has been drawn in recent years to corporate liquidity management because of difficult economic circumstances.

Factors such as r}sing interest rates, floating exchange rates, high inflation, winding down of credit, lower profits and gloomy portents for trading have made many managers realise the importance of liquidity.

"And in New Zealand devaluation must be added to all these factors as contributing to liquidity problems, Professor Juchau said.

"Establishing strong positive cash flow to meet obligations is critical for finance managers.

"No company can afford to ignore warnings of liquidity problems."

The Juchau-Flanagan-Stewart survey set out to find the opinions of Australian finance directors on the relative importance of typical liquidity management objectives.

They wanted to find out the degree of liquidity problems experienced during and since the 1981-82 period surveyed.

They sought opinions on the relative importance of factors affecting liquidity planning or management, as well as the relative importance of factors triggering awareness of liquidity problems.

Opinions on the relative importance of measures taken to resolve liquidity problems were also sought.

Only five per cent of those surveyed said they had encountered substantial liquidity problems, while 19 per cent regarded problems they had as moderate.

Fifty six per cent of the companies sailed through the recession with virtually no problems, while 20 per cent admitted to a few problems.

Interestingly, most of those who responded to the survey were companies with sales of up to $250 million a, year.

Forty three per cent of those who responded were from companies with sales of $100 million or less.

Professor Juchau said that with nearly one quarter admitting to some cash flow problems, liquidity was obviously a concern among those surveyed as well as for other Australian companies during the time covered by the survey.

How finance managers rated liquidity management objectives,.on a one-to-five scale from unimportant to very important, gave top rating over all to the ability to generate long-term debt or equity finance when needed.

Heaviest emphasis on this came from companies with sales of more than $250 million a year.

The ability to meet temporary financial problems as these arose was rated next most important with a fairly even response from companies
of all sizes.

Asset convertibility and and the availability of short-term finance were seen as being only marginally
important.

The survey evaluated 37 factors in order of importance in management of liquidity, grouping these into five categories : forecasting, ratio analysis, asset management, liability management, and other factors.

Highest rating over all went to short-term cash-flow projections of one year or less, while such projections of three years or more were seen as the least important.

Rating closely behind short-term cash-flow projections was projected earnings of the firm.

This implied that there was additional information in earnings forecasts that was not contained in short-term cash-flow projections.

This was unless the earnings projection was a long-term liquidity indicator, complementing the cash-flow projection as a short-term indicator.

Ratio analysis, generally regarded as a useful indicator of corporate liquidity, was not ranked as being highly important by those who responded to the survey.

In the ratio analysis category, profit margin was seen as the most important, just ahead of debt-to-equity ratio.

The importance of ratio analysis was seen as most important when a business was barely liquid, even slightly ahead of when a business was liquid.

Ratio analysis was seen as being neither important nor unimportant when a business was highly liquid.

The two main sources of ongoing cash, receivables and inventory, were seen as being the most important in asset management.

In liability management good relations with bankers was seen as being the most important, with aggregate lines of credit close behind.

A timely, accurate management-reporting system rated well ahead of other factors of importance in liquidity management.

Professor Juchau said that this factor rated second over all behind short-term cash-flow projections .

"This is obviously important in volatile economic conditions, such as those in New Zealand at present," he said.

Also rated important among other factors were current operating earnings, and the awareness of management of the impact of its decisions on liquidity.

In the survey finance directors were asked to rate in importance 17 factors for identifying liquidity problems and 22 measures to overcome these problems .

This section of the survey dealt with the 44 per cent of the companies that had experienced problems.

Also rated important among other factors were current operating earnings, and the awareness of management of the impact of its decisions on liquidity.

In the survey finance directors were asked to rate in importance 17 factors for identifying liquidity problems and 22 measures to overcome these problems .

This section of the survey dealt with the 44 per cent of the companies that had experienced problems.

Factors for resolving liquidity problems were grouped into sales and expense control, asset management, and liability management.

Greater cost control of overheads was seen as easily the most important in resolving liquidity problems.

"If costs cannot be passed on and there is a build-up of inventory, moving to alleviate liquidity pressures quickly can only be done by controlling overhead expenses," Professor Juchau said.

Overheads were also controlled by laying off personnel and clamping down on new hirings ; both seen as important moves.

Reducing investment in inventories was seen as the most important move under asset management, with a more rigorous receivables collection policy close behind.

Under liability management increasing the level of both short-term and long-term borrowing were seen as remedies, but these were not rated as being important.

Professor Juchau said the results of both the Australian and United States surveys should give New Zealand companies some valuable insights into liquidity management practices.

"These results provide them with a check-list to measure against their own experience and practices," he said.

Further information from Professor Roger Juchau, Professor of Finance and Accounting, Department of Farm Management, Lincoln College 8150, Canterbury, New Zealand