Is confidence in your cash position limiting your business efficiency?

Global competition among manufacturing, engineering, medical, and fast growth software companies generates increased anxiety for their incumbent financial chiefs. Both cash abundance and cash scarcity have made it increasingly important for global corporates to have a clear and accurate sense of their cash position, and since the treasury manager is the champion of cash and liquidity management, it’s become critical to empower the treasury team with ample understanding of key company objectives, and how to achieve them.

Given the role of the treasury team, cash and liquidity management is their top priority. In 2016, improving cash forecasting was the second most common priority, according to the 2015 Annual Survey by Kyriba and the Association of Corporate Treasurers (ACT). Nearly all treasury professionals manage cash position reporting and forecasting on a daily basis. In fact, cash position reporting is a high enough priority that 58% of CFOs have daily input into liquidity activities at their organisation. However, given the volume of work and level of priority, it is surprising that only 22% of companies report having daily visibility into 100% of their cash.

Why does 100% visibility elude us?

For most organisations, automating bank reporting across all corporate accounts has been an expensive and time consuming process. As a result, treasurers have often followed an 80/20 rule to ensure visibility into the majority of cash. This has not only reduced bank connectivity costs, but also reduced time spent logging into multiple banking platforms as quite often the remaining 20% of cash was spread across many banks.

Fortunately, technology offers some answers. Treasury systems offer the automation to reach almost any bank globally, with most providers offering embedded SWIFT access. In addition, with the advent of regional banking protocols (e.g. Zengin, Editran, EBICS) and lower cost SWIFT options such as MT Concentrator and Alliance Lite2, the cost to achieve visibility into all accounts and all global cash is significantly lower.

Corporate treasurers should still perform a cost/benefit analysis to ensure the value of extending bank reporting is there. More than likely, the cost of not having visibility will be higher, however.

Cash visibility should include cash forecasting, too

When considering cash visibility, it is important to include cash forecasting in the discussion. Having certainty into existing cash is crucial for any treasurer. But without an understanding of future cash inflows and outflows, it is difficult to make confident decisions on how to best utilise cash. After all, the value of cash visibility is actually in the decisions it enables. And in treasury those decisions include investing, repaying debt, committing cash to early supplier payments, as well as improving the effectiveness of an FX hedging program.

Without transparency into future cash needs, treasurers are forced to be very conservative in their decision making, which minimises the value of achieving cash visibility in the first place.

The value of forecasting

An effective cash forecast directly impacts many key performance indicators that senior finance executives regularly measure, and on which they are themselves measured from return on investment and cost of funds through to liquidity and solvency ratios.

If forecasted cash flow falls short of the forecast, the cost of funding can increase dramatically, as does the risk of working capital drying up and bank covenants being breached. Conversely, if net cash is higher than forecast, investment returns are depressed, while opportunity costs are increased, particularly in low margin, capital or innovation-intensive industries. In addition to liquidity management, cash flow forecasts form a critical basis for identifying, monitoring and hedging risk.

These problems, particularly lack of available or affordable financing, are real concerns that have resurfaced with banks reviewing their own portfolios due to Basel III compliance. Banks are becoming more selective in their financing decisions, and in some cases encouraging clients to consider off-balance sheet financing methods, such as receivables or payables financing. These alternative financing programs take time to set up and rely heavily on accurate forecasts, further emphasising the value of cash visibility and forecasting accuracy.

It is therefore in every CFO and senior finance executive’s interest to ensure that treasury is equipped to produce the most accurate, complete and timely forecasts possible to improve key performance indicators and inform high quality decision-making.

Ways to improve forecasting effectiveness

The key to effective forecasting is to generate an accurate forecast that treasury can be confident in relying upon. Of course, that is easier said than done. But there are techniques treasurers can consider that will help.

Forecasting sources

Where you get your information and whom you get it from is important for forecasting success. Relying on ‘treasury expertise’ is unnecessary when there are internal systems (such as ERP), regional finance heads (whom are closer to the business in each region), and often a team in FP&A who have better insight. The trade-offs are reliability and lack of integrated data, but both can be solved easily.

Reliability can be assessed through detailed variance analysis while automation in the TMS can provide an electronic on-ramp into the treasury forecast. Broadening the sources to draw forecasting data will offer better information and analysis.

Extrapolating history

There is always much discussion around how to best use historical data. Is past performance truly an indicator of future cash flows? The answer is…sometimes.

Much like choosing to use A/P and A/R data from the ERP or choosing specific numbers from an accrual based budget forecast, there are certain line items that are pattern based and can be predicted from analysis on historical cash flows: which cash flow categories are suited for this analysis will depend on the business. However, it is critical to have the flexibility to not only copy averages of prior numbers (e.g. what was last quarter’s average days to receive payment) but also be able to offer trending and regression on the data, as simple averaging can hide important patterns in the data that would otherwise offer misleading conclusions.

Variance Analysis

The most important process in cash forecasting is the detailed analysis of actual to forecast. Variance analysis can mean different things, but what is important in cash forecasting accuracy is to understand for each line item and at each time interval exactly where the variances arose so action can be taken. A poorly done analysis might only capture that the forecast was 90% accurate for the prior quarter. A more thorough review will uncover whether the 10% difference was across the board and specific to certain regions, line items, or due to misses for a couple weeks only.

It is this level of detail that, once communicated back to the owners of the data sources, can drive actual change to forecast projections and ultimately allow treasury to make more confident decisions based upon the greater certainty of future cash flows.

One constraint with this level of analysis is the greater need for data – effectively snapshots of the forecast on a daily or weekly basis must be taken and then stored away for later comparison. The exercise will stress any spreadsheet (and its users), so oftentimes a TMS will be required to do the job with automation and precision.

In Summary

Having confidence in your organization’s cash position empowers CFOs and Treasurers to make effective decisions, including investing, borrowing, and hedging as well as more strategic initiatives such as share repurchases, acquisitions, and entry into new markets. The value of the cash visibility, including forecasting, is measured by the ability to make those decisions effectively.

By Bob Stark, VP of Strategy, Kyriba.

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