For government entities and public sector organizations, managing liquidity risk is crucial to ensuring consistent operations, maintaining public trust, and avoiding disruptions in services.
Even if an organization is financially sound on paper, with assets and funding secured, liquidity risk can still arise if those funds aren't readily available for day-to-day use. Timing issues between incoming revenues and outgoing expenses are often at the heart of liquidity challenges.
Example of Liquidity Risk in a Business
Imagine a local government is waiting on a large reimbursement from a federal grant to fund a public health program. Meanwhile, payroll, vendor payments, and utility costs are coming due. If the grant funds are delayed and there’s not enough cash on hand to cover these costs, the government faces a liquidity crunch.
To keep services running, it may need to take on short-term debt or tap into reserves, both of which can come with financial and political consequences.
How to Manage Liquidity Risk
To manage liquidity risk effectively, government finance teams can adopt several best practices:
- Maintain cash reserves: A healthy reserve can serve as a buffer against unexpected shortfalls.
- Use cash flow forecasting: Regularly forecasting inflows and outflows helps anticipate timing gaps before they become a problem.
- Conduct daily cash positioning: Knowing exactly how much cash is available each day enables smarter, faster decisions.
- Centralize financial data: Consolidated data makes it easier to monitor liquidity across departments and funds.
- Establish access to short-term funding options: Having a line of credit or other funding mechanism in place can provide flexibility during timing delays.
What's important here?
Liquidity risk isn’t just about how much money an organization has overall—it’s about whether that money is available when it’s needed.
Even financially healthy government entities can face liquidity challenges due to delays in revenue or unexpected expenses.
That’s why it’s critical to actively manage liquidity through tools like cash flow forecasting, daily cash positioning, and maintaining sufficient reserves.
These strategies help public finance teams stay ahead of shortfalls and keep essential services running smoothly.
