Liquidity risk

Liquidity risk refers to the difficulties that can arise from an inability of the company to meet its short-term financing needs, i.e. its ratio of short-term assets to short-term liabilities. Specifically, this refers to the organisation’s working capital and meeting short-term cash flow needs. 

The essential elements of managing liquidity risk are, therefore, the controls over receivables, payables, cash and inventories.

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Manufacturing has historically had a greater challenge with the management of liquidity risk compared to some other sectors (especially low inventory businesses such as those in service industries)

There are 2 main reasons:

Firstly, manufacturing usually requires higher working capital levels because it buys in and sells physical inventory, both on credit. 

• This means that both payables and receivables are relatively high. 
• It also, by definition, requires inventory in the form of raw materials, work-in-progress and finished goods, and therefore the management of inventory turnover is one of the most important management tasks in manufacturing management. 
• In addition, wages are paid throughout the manufacturing process, although it will take some time before finished goods are ready for sale.

Secondly, manufacturing has complex management systems resulting from a more complex business model. 

Whilst other business models create their own liquidity problems, the variability and availability of inventory at different stages and the need to manage inventories at different levels of completion raises liquidity issues not present in many other types of business (such as service based business).