In recent research conducted by BDRC for ABN AMRO’s Working Capital Group, 82 per cent of respondents said cash flows could be predicted with reasonable accuracy up to two to three days ahead, but, significantly, this fell to 72 per cent for a week’s horizon and to 20 per cent for a two-month horizon. And, according to respondents to our survey, account receivables, the timing of payments and non-centralised cash management activity are major factors impacting the predictability of cash balances.
Source: ABNAMRO/BDRC Survey Q4 2003
It is certainly well worth the effort to implement a discipline for getting visibility of what cash flows are likely to be in the future. Clearly, improved cash forecasting enhances investment and debt management. Additionally, the ability for headquarters to quickly identify unexpected turns in cash flows has significance in terms of financial control benefits – at a time when this issue is receiving much scrutiny from regulators and shareholders.
So, what can treasurers do to improve visibility of cash flow in operating units?
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- Establishing robust cash forecasting requires close co-operation and co-ordination between treasury and business/operating units. As a first step, therefore, it is extremely important to gain support from senior executives, including the CFO, for an explicit programme to improve performance in this area. A strong case can be made based on the combined merits of the investment/debt management and control benefits even (or, perhaps, especially) for companies that are net investors and have significant balance sheet cash and investments. That said, some companies have found it necessary to provide incentives at operating company level in addition to putting the case for overall company benefit.
- Next, the company will need to construct a “top-down” model that can be used as the basis for projecting cash flows. This entails:
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- Analysing historical bank cash levels and inflows/outflows to establish the nature/predictability of each major flow component, whether as a result of operating activity such as accounts receivables and payables, or treasury activity such as debt and dividend payments. The bank account data should be readily available to treasury (as a download from its Treasury Workstation or electronic banking platform into spreadsheet software). Subsequently, understanding cash flow components will require working with business/operating units. The purpose is to identify flows that are overseen by treasury (eg, all treasury-related activity), those under the control of business/operating units (eg, payables in decentralized companies), and those outside the company’s direct control (eg, customer receivables).
- Building a predictive model, which will include the application of “knowns” and extrapolation of past data. Standard spreadsheet software is perfectly adequate for this and, in fact, more useful than treasury workstation software for this purpose. Extrapolating past data is generally quite usable for short-term time horizons (up to three to six months). Depending on the nature of the company’s business and resources available within treasury, this extrapolation may actually use techniques that are simple or complex – from seasonally adjusted moving averages to statistical time-series analyses.
- Most companies will also need a “bottom-up” process for business units to send in their periodic projections of major cash movements. The more decentralized and diverse a company’s business, the more essential it will be to have regular flow information from the business/operating units in addition to the top-down model. Gathering this will typically require business units sending monthly updates of anticipated flows for the next 60-90 days. (Establishing this discipline with business/operating units will, of course, require the senior management support noted earlier). Depending on the infrastructure available to a company, this data-entry could be done through a standard spreadsheet template, or web-based entry into a screen on the corporate intranet or treasury workstation. The latter will certainly allow for easier data integration, but the option will not be available to all companies. However it is collected, this data will equip treasury with key information to “fine tune” the outputs from the predictive model described earlier.
- Finally a variance analysis and feedback process should be established and used to assess, on a regular basis, the accuracy of cash flow forecasts compared to reality. The purpose of this is to identify causes for significant divergences, whether in the model or due to the effort those business/units are using to provide their projections and take appropriate action.
All of this may seem a bit daunting, and it is true that building a good cash flow forecasting programme takes some effort. However, the results will provide rapid payback for the effort. Treasuries should certainly network with their peers and seek guidance from those who have been through a similar process. If there is budget available, a consulting firm experienced in this area could be used to facilitate.
A final note. Maintaining flexibility in investments will also help companies deal with the unpredictability of cash. In the same research noted earlier, companies also cited the fluctuating size of their balances. In a relatively flat yield environment for short-term investments, corporate treasurers should balance risk and efficiency by using flexible investment options that can optimise returns without compromising liquidity or increasing risk. For example, high yield current accounts and money market funds combine convenient access, daily liquidity and the potential to enhance returns. The use of term deposits and money market instruments, by contrast, is typically more resource-intensive, requiring active pricing, monitoring and multiple transactions. This should be taken into account in establishing the company’s investment strategy.
