Cash visibility for corporate treasuries

By Paul Higdon,
chief technology officer,
IT2 Treasury Solutions

The essential role of cash management operations is to ensure that the business has the cash it needs, at the right place, and at the right time. Failure to achieve this strategic objective can directly impact the efficient commercial operation – and ultimately the viability – of the organisation. A dependable flow of cash ensures that the business units have access to the liquidity that they need for their day-to-day activities; and their teams can therefore focus with confidence on core business operations.

In IT2’s most recent survey of corporate treasuries, 79 per cent of respondents reported that increasing the visibility and mobility of cash was a priority for their treasuries. This compelling result indicates that, three years on from the financial crisis, cash management remains a major focus for treasury operations. Optimisation of the cash management process ensures that cash is efficiently used to meet the organisation’s liquidity needs, sustaining growth and corporate profitability.

In this article, the central elements of cash and liquidity management are analysed as follows:

– Achieving global visibility of the cash position;
– Optimising the cash flow forecasting process;
– Enabling the necessary cash mobility, for funding and cash investment.

Together, the efficient execution of these activities enables the organisation to accomplish the end-to-end visibility – and hence the effective management – of corporate cash flows.

Global visibility of the cash position

Achieving the best practice treasury management goal of global cash visibility might seem like a deceptively simple sounding objective. In practice, the level of cash visibility in most organisations falls short of the ideal: IT2’s 2010 Annual Treasurers’ Survey respondents showed an average result of 78 per cent of the organisation’s total cash being visible; the responding group anticipated that this would rise to 91 per cent within three years.

The technical foundation of generating an organisation’s daily cash position requires the uploading and updating of all the bank account balance reports. Again, the requirement sounds simple; in practice, large multinational corporations – especially those with decentralised corporate organisations – are often served by complex global webs of bank relationships and bank accounts, without an automated mechanism for achieving timely central visibility. In some cases, in which the responsibility for opening and maintaining bank accounts is diffused around a global organisation, the very existence of some accounts may be hidden. Lacking visibility of the entire bank relationship network, there is no real chance to utilise cash efficiently, and so the organisation is likely to use its borrowing lines and facilities in an inefficient way. This incurs unnecessary bank interest and transactional costs; and it indicates that more – perhaps much more – working capital is being consumed than is in fact necessary to fulfil operating needs. Locating ‘trapped cash’, and putting it to work, is what is needed to rectify such situations.

Deriving the cash position from the enterprise’s bank account balances is a function of the bank reporting solutions in use. The technical demands of this exercise are, essentially, directly proportional to the complexity of the bank relationship network, and of integrating and controlling – and perhaps rationalising and centralising – the reporting systems in use.

A new dimension in cash visibility and control is offered through Electronic Bank Account Management (eBAM). eBAM may be defined as the provision of controlled web-based workflows and electronic messaging related to the opening, maintenance and closing of bank accounts. Effective bank account administration with eBAM enhances the quality and control of bank account management, regardless of whether the ultimate responsibility is centralised or decentralised; it therefore enhances the quality of cash visibility. At present, eBAM evaluation and adoption is in its early stages among corporate treasurers.

High quality cash visibility requires the combination of robust bank account balance retrieval and consolidation with effective bank account
management. Today, there is still some distance to travel to achieve visibility levels in excess of 90 per cent, so it seems that this area will remain a primary treasury development focus for some time ahead.

Optimising the cash forecasting process

A range of different cash forecasting methodologies is found within the global corporate treasury community. Some methods are based on building the picture from the ground-up using business units’ commercial forecasts; others work top-down based on budgeted cash flow; others use statistical modelling methods.

Ground-up forecasting: This approach is based on commercial forecasts originating from operating units; these must be periodically submitted and updated by the originators. This method has the benefit of direct linkage with the entities which are responsible for the flows which are being projected; but it has comparatively heavy data collection and validation aspects.

The enhancement of cash flow forecasting based on the ground-up approach centres on improving the accuracy and timeliness of the forecasts received from the company’s business units. Web-based solutions provide an optimal approach for efficient forecast collection; this approach enables the business units to submit their data at a convenient time for them, using intuitive, customised forecast templates that are easy to use, and which encourage accuracy. The automation of the process enables the information to be collected and analysed centrally, with the facilities to send prompting messages to late reporters, and to analyse forecast versus actual performance as an aid to measuring and improving forecast quality.

The detailed construction of the complete cash forecast involves the integration of information from a variety of sources, including treasury transactions, and accounts payable and receivable data, in addition to the management of the longer term forecasts. The committed flows may be applied to the bank-based cash position. The details of implementation, including the forecast time horizon, will vary from company to company, depending on the structure and patterns of the business.

Top-down forecasting: Top-down forecasting uses the budget as the starting point, and allocates the projected flows across the business structure over the defined duration of the forecast. It relies on the retention of the critical data for the required time-span, combined with adjustments based on known seasonal fluctuations and related variable factors. Such methods do require the facility to build in systematic changes that invalidate the relevance of some part of the historical model.

Statistical modelling: Statistical modelling is a ground-up approach which involves cash prediction based on one or more customisable forecast models, which are applied to the historically reported cash flow. At a high level, this approach provides a flexible analysis of cash flow history, uses that analysis to predict future cash flows employing one or more modelling techniques, and automatically generates, stores and reports future cash flow predictions.

A treasurer using statistical modelling will need to define the forecast framework, so that individual cash flow types may be assigned to the correct category in the model.

The models may utilise a user-defined linear growth pattern, or moving average, or linear regression, or seasonally adjusted trends, refined with the facility to eliminate extreme cases or outliers.

As a practical example of the use of this type of model, a company might forecast sales based on one-year seasonality for every month of the year, based on an increase of 10 per cent on the sales of the same month of the previous year, by selecting a prediction frequency of monthly, a base past period of twelve, applying the model to every month in the period, and using a fixed percentage of 10 per cent.

The moving average model bases its predictions on a number of previous periods, and produces a weighted (or un-weighted) average as its prediction for subsequent periods. The treasurer needs the facility to define the number of prior periods that will be included in the predictive analysis. This model includes the facility to apply exponential weightings of less than one, which has the effect of applying higher weightings to more recent values, as cash forecast policy sometimes requires this approach, if it is judged that recent values are a better predicative indicator. For example, a sales forecast for a company whose sales are recorded quarterly and show heavy seasonal linkage could be treated by selecting a prediction frequency of quarterly, using five previous periods, modelling for every four periods, and using an exponential weighting of 1.0.

The linear regression modelling method attempts to fit a trend line to previous data, and extrapolates this line to forecast future flows. In this case, the treasurer needs to define how many, and which, previous periods should be included in the analysis. This type of model allows the treasurer to eliminate extreme data outliers from the analysis.

Statistical modelling may be used in isolation or in combination with other forecasting methods, in which case its function may be to validate the results of forecasts which have been derived by other means. For example, a subsidiary may have forecast a $10 million receivable in April, but the historical trend indicates that $8 million is to be expected; treasury policy should specify how such differences should be researched, analysed and explained.

The cash forecasting process enables the treasury to project cash visibility into the future and enhance the treasury team’s potential to manage cash proactively. The selection of the correct forecasting approach for a given company is a demanding process, which, when effectively performed, enables funding and investment operations to be more accurately planned.

Cash mobility

Treasuries that have achieved a high degree of global cash visibility combined with optimised forecasting are in a superior competitive position to deploy the cash effectively, where and when it is needed. The necessary methodology requires integrating information from bank-operated cash pooling arrangements, and from internally operated in-house banks and payment factories.

In-house banks rely on treasury technology to offer cost effective financial services to the entire organisation, helping to optimise interest income/expense performance through efficient inter-company operations and the reduction of bank fees and transaction charges. In-house banks support notional pooling and physical sweeping ZBA (Zero-Balancing) accounts, validating banks’ operations and allocating interest to the pool members. Additionally, they can initiate the manual or automated target/peg balance transfers for funding shortfalls and sweeping excess cash, effectively putting the organisation’s internal cash to work where it is needed.

Payment factories provide cost effective centralisation of bulk payment management, offering secure, robust facilities. They offer a standardised means of access to commercial cash flows, providing summary level information to central cash management.
Cash mobility includes secure treasury payments management, for the initiation and control of payments for deal settlements and maturities, and for other treasury based cash flows such as coupon, option premium and margin payments, cash transfers and ‘payments on behalf of’. The process will extend to bulk payments for those larger organisations which operate payment factories.
Cash mobility enables treasuries to originate the fund movements needed to optimise short term funding and/or cash investment, including Money Market Fund investments.

And finally…

This article has summarised the essential components through which a corporate treasury department can gain end-to-end visibility over the organisation’s cash flows, leading to more effective funding and investment operations. This in turn leads to a reduction in working capital demands as the hidden cash within the organisation is put to work as needed. Such results have very positive effects on the creditworthiness of the enterprise, and also improve interest income/expense performance. The benefits feed directly into the financing of the business, and hence to facilitating effective commercial operations.

The continued prominence of cash and working capital management in the treasury industry strongly suggests that innovative treasurers will continue to strive for performance improvement in this area, helping their organisations to navigate an uncertain future with greater confidence.

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