Time To Tap Into Liquidity?

As the economy improves, finance staffs scramble to adjust their liquidity strategies.

In this shaky economic recovery, finance executives face a difficult decision: Should they continue to stockpile liquidity? Or should they start converting cash into inventory and capital investments that will position their organization for growth

For the past several years, tight credit has shut many companies out of the capital markets and forced them to rely on internally generated liquidity, notes Niko Havoutis, senior vice president and global head of liquidity and investments with JPMorgan Treasury Services in New York City. But now external liquidity sources, especially banks and the capital debt markets, are conspicuously open for business again. Interest rates are low, but many finance pros expect them to rise before long. Companies that issue bonds now may be able to fund future projects at rates well below market, gaining an edge over the competition.

At the same time, borrowing to raise the organization's liquidity level presents risks. New funds will have to be invested in short-term financial instruments at rates well below the bond coupon rate. That creates a negative spread which will consume earnings until the cash can be profitably invested in business opportunities that yield a better return, notes Anthony J. Carfang, partner with Treasury Strategies Inc. in Chicago. And if those opportunities don't materialize, the extra liquidity could become a crippling drag on the company's performance.

During the credit crunch, most liquidity decisions were no-brainers. When the economy is tanking and interest rates are low, savvy treasuries accumulate and conserve cash, regardless of the impact of that strategy on earnings. Maintaining adequate reserves is the top financial priority. "It's your safety net. It's what you have to ride out a recession," observes Carfang. "When you're thinking defensively, you hoard liquidity, maximize investable cash, and protect your credit rating and backup credit facilities."

When the economy is booming, "liquidi-ty becomes your offense," says Carfang. "It's what you have to seize opportunities. When you're thinking offensively, you're more likely to issue long-term debt to finance capital investments that will grow the business."

But optimum liquidity is not always maximum liquidity, and that's particularly true when the economy is in the early stages of an upswing. This recovery seems far from robust, and finance pros must carefully weigh the trade-offs among cash reserves, debt levels and capital outlays.