Importance of Liquidity Risk Management
1. Managing Working Capital: Liquidity management helps in optimising the cash flow cycles by which companies can improve their liquidity position and enhance profitability. It plays a crucial role in maintaining the working capital of the company. Working capital represents the operational liquidity of the business and its ability to meet short-term obligations.
2. Financial Stability: Effective liquidity management reduces the risk of liquidity crises and provides financial stability to the business. By maintaining sufficient cash reserves and liquid assets, a business can survive economic fluctuations or disruptions in financial markets. The liquidity position is considered a crucial factor while assessing the creditworthiness of a business.
3. Meeting Short-Term Obligations: A business having adequate cash reserve, and liquid assets can meet its short-term obligations such as paying off short-term debts, payment to employees and any charges. This ensures the faith of the customers and other stakeholders in the organisation.
4. Managing Risk: It is important to maintain appropriate levels of liquidity as it helps in mitigating the risk of financial distress. Maintaining sufficient liquidity can reduce the reliance on bank loans or other credits having interest costs or other financing charges. Self-financing with the help of cash reserve will help reduce the cost and lower the risk.
5. Growth Opportunities: Liquidity management allows businesses to expand by having the necessary funds available to invest in new projects or acquire assets. Adequate liquidity can facilitate strategic decision-making and position a company for long-term success.
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