what is asset liability management 
asset liability management is the process of managing the use of assets and cash flows to reduce the firm s risk of loss from not paying a liability on time well managed assets and liabilities increase business profits the asset liability management process is typically applied to bank loan portfolios and pension plans it also involves the economic value of equity understanding asset liability managementthe concept of asset liability management focuses on the timing of cash flows because company managers must plan for the payment of liabilities the process must ensure that assets are available to pay debts as they come due and that earnings or assets can be converted into cash the asset liability management process applies to different categories of assets on the balance sheet important a company can face a mismatch between assets and liabilities because of illiquidity or changes in interest rates asset liability management reduces the likelihood of a mismatch a defined benefit pension plan provides a fixed pre established pension benefit for employees upon retirement and the employer carries the risk that assets invested in the pension plan may not be sufficient to pay all benefits companies must forecast the dollar amount of assets available to pay benefits required by a defined benefit plan assume for example that a group of employees must receive a total of 1 5 million in pension payments starting in 10 years the company must estimate a rate of return on the dollars invested in the pension plan and determine how much the firm must contribute each year before the first payments begin in 10 years examples of interest rate riskasset liability management is also used in banking a bank must pay interest on deposits and also charge a rate of interest on loans to manage these two variables bankers track the net interest margin or the difference between the interest paid on deposits and interest earned on loans assume for example that a bank earns an average rate of 6 on three year loans and pays a 4 rate on three year certificates of deposit the interest rate margin the bank generates is 6 4 2 since banks are subject to interest rate risk or the risk that interest rates increase clients demand higher interest rates on their deposits to keep assets at the bank an important ratio used in managing assets and liabilities is the asset coverage ratio which computes the value of assets available to pay a firm s debts the ratio is calculated as follows asset coverage ratio bvta ia cl stdo total debt outstanding where bvta book value of total assets ia intangible assets cl current liabilities stdo short term debt obligations begin aligned text asset coverage ratio frac text bvta text ia text cl text stdo text total debt outstanding textbf where text bvta text book value of total assets text ia text intangible assets text cl text current liabilities text stdo text short term debt obligations end aligned asset coverage ratio total debt outstanding bvta ia cl stdo where bvta book value of total assetsia intangible assetscl current liabilitiesstdo short term debt obligations tangible assets such as equipment and machinery are stated at their book value which is the cost of the asset less accumulated depreciation intangible assets such as patents are subtracted from the formula because these assets are more difficult to value and sell debts payable in less than 12 months are considered short term debt and those liabilities are also subtracted from the formula the coverage ratio computes the assets available to pay debt obligations although the liquidation value of some assets such as real estate may be difficult to calculate there is no rule of thumb as to what constitutes a good or poor ratio since calculations vary by industry key takeaways fast fact asset liability management is a long term strategy to manage risks for example a home owner must ensure that they have enough money to pay their mortgage each month by managing their income and expenses for the duration of the loan 