^[1]A 1980s CFO taught me a simple mantra, “Liquidity, Liquidity, Liquidity.” For him, a firm could not have too much of it. The rationale: a liquidity crisis, the inability to meet daily cash requirements, could put you out of business faster than any other risk.

While in the intervening 25 years new risks have emerged, his lesson continues to be on the money. Insufficient cash flow results in bankruptcy. 

Examples abound

In the corporate world, Lehman Brothers, Drexel Burnham Lambert, and PennCentral are examples of firms that collapsed because of their inability to re-finance their overnight obligations. During the recent financial crisis, Harvard University had trouble meeting its cash obligations despite its multi-billion dollar endowment and Boston-area real estate.   

Sovereign nations face liquidity problems too. Current events in Greece and other Eurozone countries vividly demonstrate the challenges of dealing with a nervous bond market. Experience shows that defaulting will prolong the pain. Access to the capital markets may be closed for years. Ten years ago, Argentina defaulted; that country still cannot issue sovereign debt.

Individuals are not immune to this problem either. While the details are slightly different, the result of a liquidity crisis is the same, bankruptcy. Not a happy result for any entity – whether a country, a corporation, a not-for-profit, or an individual.      

Lessons for a Leader

Liquidity crises can be mitigated or totally averted with proper preparation. To achieve this objective, leaders need to:

     1.  Explain liquidity’s importance 

People cannot manage risks they do not understand. Taking a page from the reporter’s notebook, explain what liquidity is, how to measure it, where and when it is needed, and why it is important. Once its significance is comprehended, attention can be focused on it. 

      2.  Seize the moment

For corporations, liquidity usually comes with a cost. However, there are times, when liquidity can be obtained at little to no cost. Leaders seize these opportunities.

For instance, when my New York City coop refinanced the building’s underlying mortgage, two banks proposed identical terms; one bank also offered a free, 10-year line of credit.   Because of the availability of emergency cash, which the Coop pays for only if needed, that Bank got the deal.   

The bond markets also offer opportunities when they charge very little for liquidity. It is at those times that a savvy CFO/Treasurer stocks up on liquidity. 

      3.  Regardless of size, plan for the worst, hope for the best

Each year, a savvy leader develops a 30/60/90 day plan for a liquidity crisis: what to do if an organization can not roll over its liabilities, receivables do not get paid off as fast as you anticipate, etc. 

For large organizations, a contingency plan needs to be well thought out, taking into account potential asset sales, reduction in credit extensions, lines of credit, etc. In smaller firms, the plan can be very simple. For instance, my Manhattan Coop maintains 3-4 months of income in reserves, customary for a well-run New York City building. When I opened my consulting practice, a colleague advised me to keep nine months cash on hand to withstand slow paying clients. 

Benefit

A well-thought out liquidity plan will enable an organization to remain in business even if the credit markets suddenly shut down. In the 1990s, Solomon Brothers could not re-finance its maturing liabilities. However, it had a liquidity plan in place that allowed it to stay afloat until it was purchased by a deeper pocketed competitor. While not optimal, it allowed the firm to retain shareholder value and its staff stayed employed.

Charlotte Nad consults with leaders and senior managers on business and organizational effectiveness.