In a time when cash and liquidity are uppermost in treasurers’ minds, we look at why effective cash segmentation is so important.

When all is said and done, it’s cash that makes the business world go round. Short-term is the big concern for many businesses in the current COVID-19-constrained trading environment. With revenue streams hit hard, the pandemic has impacted the cash and liquidity positions of many companies. But not all are impacted in the same way.

Companies with large cash buffers and low leverage and debt-servicing costs will be more resilient than those leveraged to the hilt. Some sectors are naturally more robust than others in the current situation. Online retailers and supermarket chains are clearly benefitting from increased cash flow. Many of those in the travel and tourism sectors are suffering existential crises.

Even the so-called ‘defensive industries’ (those that are relatively immune to economic fluctuations, such as the supermarkets) are facing new challenges with COVID-19. As infection rates peak, the supermarkets have had to develop their logistics infrastructures in order to satisfy rapidly rising demand. For some, it was a matter of assessing whether increased demand would be sustained long enough to get sufficient return on any infrastructure development costs, or whether post-COVID-19 their expanded logistics infrastructure would absorb too much cash.

Cash control

“Any crisis, like the great financial crisis in 2008 or now the corona crisis, always highlights the importance of liquidity and the old corporate treasurer’s truth ‘cash is king’. It is therefore crucial to have good control over your organisation’s funds.” Thus states Christian Bartsch, a treasury and finance consultant, managing director, and Professor of Business Administration (Finance & Accounting) at IUBH University of Applied Sciences, and Adjunct Lecturer at EU Business School, Munich.

One way to achieve essential control is by cash segmentation. This, he explains, is the division of an organisation’s funds into categories to increase financial stability and promote better control over assets and – at the same time – the budget process. The most common divisions under cash segmentation are operating cash, reserve cash, and strategic cash. However, he notes, some organisations may also have restricted cash division.

For Aziz Parvez, Head of Asia Pacific Corporate Treasury Sales, Global Transaction Services, Bank of America, the extent to which is it necessary to have a clear picture both of cash holdings and capital planning is clear.

“It is extremely important for a company’s treasury to segment cash, not only to ensure that day-to-day cash needs are properly catered for but also companies’ mid-term requirement and long-term visibility of cash positions to support strategy objectives and expansion plans are met,” he says.

Parvez acknowledges that this has become particularly relevant against the backdrop of a pandemic and global economic slowdown. “Now more than ever, companies need to ensure visibility and accuracy of their cash flows so that they can plan ahead and ensure their funding requirements are fully supported in these challenging times.”

Thomas Stahr, Interim Treasurer, Treasury Consultant and Project Specialist, believes too that it is essential for treasurers to divide cash into core segments. This, he says, “starts with cash which is available on the balance sheet but which cannot be accessed because it is trapped, and goes all the way to cash that is causing negative interest on credit and, above all, with particular attention given to the currency in which cash is available or needed”.

Indeed, the current circumstances of collapsing economic demand on the one hand, and negative interest rates for cash in EUR and CHF on the other, “are the two biggest cash challenges a treasurer should have under control at the moment,” says Stahr, a former Head of Corporate Treasury at global airport ground services firm, Swissport.

“The goal in an uncertain economic situation must be very clear: to secure sufficient short-term and medium-term liquidity,” he warns. This means “a healthy mix” of committed and uncommitted credit lines is the first choice, because these generate the lowest costs. “But planning early refinancing to secure long-term liquidity is also a priority during this period.”

The current economic circumstances have indeed changed client goals, reports Parvez. “Clients are focused on short- and medium-term cash requirements,” he says. The key focus right now is to ensure a sufficient cash buffer to see the business through the current situation. “This has become important not only to manage the operational needs of the companies but also from a rating perspective, given the shifting credit environment.”

Levels of segmentation

It depends on what the operational business of the company is, as to how detailed and layered the segmentation process is. A company that produces machinery has different cash requirements to one that is a wholesaler, and different again from one that is engaged in insurance or banking. But all areas have one thing in common, and that is ensuring minimum liquidity for the operational business and investments.

Three levels of segmentation are the most effective, covering operating cash/working capital (short-term), reserve cash (medium-term), and strategic cash (long-term).

• Short-term. Short-term forecasts provide the cash detail needed to help manage working capital and to protect day-to-day company liquidity, covering the immediate cash inflows and outflows that affect overnight balances. Daily and even intra-day forecasts ensure that treasury keeps abreast of last-minute changes to cash flows. Weekly and monthly forecasts (for up to about three months) provide advance warning of the expected cash positions.
• Medium-term. Rolling monthly forecasts for up to 12 months ahead help to predict cash needs and surpluses further into the future. They help to show where the high and low points of cash availability are likely to occur through the course of the year as well as identify when existing investments and debts may be maturing.
• Long term. Long-term forecasts may cover up to a three or even five-year period. They provide a longer view of potential surplus resources and financing needs to help ensure that a company’s business plans and strategies can be properly funded. They also help to identify future cash that has not yet been ‘earmarked’ for use and is therefore available to invest for a longer time period.

Vital forecast

In terms of applicable technique, first of all, it is extremely useful to establish well-structured reporting of required liquidity, per entity and currency, and then to consolidate that data, urges Stahr. “The whole process should be on a time axis with a minimum of nine months, but better still over one year.”

The aim here is to determine all cash requirements in detail. This should result in a clear understanding of the financing surplus or financing gap. “Always pay attention to the facts of effectively available liquidity,” he advises.

In theory then, corporate treasuries can easily gain control over the organisation’s assets at any given time by embracing cash segmentation, Bartsch says. But first there is a need to have a detailed cash forecast that directs organisations to which cash segment their money is allocated, in order to survive tough economic times or crisis.

Cash forecasting is one of the most important and effective tools in cash segmentation, agrees Parvez. “It has also been a top priority for corporate treasuries, and recent events have only reinforced its strategic worth in carrying the company through this difficult time and the future.”

Although forecasts still tend to be less accurate than most treasurers would like them to be, they do (or should) provide a realistic view of future cash resources, and therefore provide an early opportunity for identifying potential surplus cash or funding gaps, as well as other essential information such as currency denomination, present location, total amount (value) available, planned future location (and currency), and time horizons (the length of time cash will be available for investment before it is needed by the business).

In addition, forecasts will help treasury to define how ‘important’ the cash is to the business’s daily operational activities and what the impact would be on the company if the cash to be invested was not readily available to meet day-to-day obligations.

From this point, it is up to the treasurer to define, introduce, optimise and, where necessary, expand the adoption of the appropriate instruments. This starts with cash concentration or cash pooling, continues with extending credit lines, even arranging syndicated loans, and ends with the placement of capital market bonds.

For surplus cash, investments need to be forecasted over two to three years. Accurate prediction reduces the risk a company may experience if the investment were to fail under the current economic times as a worst case but more likely counter sub-optimal investing, or the possibility of overestimated surplus cash having to be pulled from investments at short notice or inability to liquidate in time to meet business needs.

“In the current business environment, corporate goals and objectives have changed as many organisations focus on accomplishing short-term goals that lead to long-term ones,” says Bartsch. For instance, he notes short-term goals are easier to achieve now, compared to long-term ones, due to the emergence of the pandemic, especially given that forecasting in such tough times is extremely challenging.

What’s more, he observes that the use of funds has been reduced, due to current uncertainties, that “would create havoc in organisations if the economic situation does not change in the future”. He notes too that a rise in debt has been recorded as many businesses seek to benefit from bank loans, which they may be unable to service on time.

Indeed, the World Bank reports that the debt crunch has made it hard for decision-makers and managers in industries where the production of goods is the main activity. Most organisations, it says, are also focusing on increasing strategic and reserve cash due to the current uncertain financial condition. However, says Bartsch, the operating cash division must be monitored as any eventuality will need to be catered for using these funds.

For many, this is a cash balancing act that could have troubling consequences if the numbers are wrong. Distressed organisations are trying to find emergency liquidity, and cash-rich businesses are having to think ahead and engage with a wide range of ‘what-if’ scenarios as they reinforce their liquidity positions.

Suitable approaches

When it comes to the three segments, corporate treasuries should maintain a constant flow of funds to the operating and reserve cash divisions, advises Bartsch. This approach will help treasuries to create appropriate financial plans, given that operating in the current environment requires proper economic forecasting to eliminate the chances of insolvency. Thus, he adds, “this calls for corporate treasuries to communicate with other departments to ensure prioritisation of projects”.

Indeed, he says, one of the most effective cash segmentation approaches in the current business environment is the budget model. This strategy allows corporate treasurers and accountants to determine what an organisation requires at the present and forecast what might be necessary for the future.

The budget model covers all the elements of an organisation, making it more accurate in handling financial issues that arise in the day-to-day operations. Nevertheless, Bartsch adds, this model must be regularly compared to the forecasting model that identifies future risks (the forecasting model mainly used in financial planning and analysis incorporates all the aspects of the organisation in minimising risks and looking for opportunities).

If most companies operating cash segmentation every financial year obtain a scope of what should be done during that period, Bartsch believes that a combination of all three divisions can be effective in the current business environment, “because they cover the short-, medium- and long-term needs of an organisation at the same time”. The use of this approach can help corporate treasuries to allocate funds to different departments effectively, being based on an informed assessment of the short- and long-term needs of an organisation.

However, warns Bartsch, a segmentation review should be conducted after every quarter of the financial year to eliminate ‘interferences’, with corporate treasuries monitoring every task or operation to ensure that money is spent appropriately. Parvez agrees, saying that review is necessary “to ensure that any changes to market or economic conditions are assessed and acted upon on time”.

Current risk response

Corporate treasurers have a further significant role to play in the current business environment because they must respond by allocating funds to risks rather than expanding portfolios, suggests Bartsch. “Risks affect the financial aspect of an organisation, hence cash segmentation should be focused on making short-term agile decisions with long-term effects.”

Good liquidity planning must therefore always be a top priority, adds Stahr. Due to events that have arisen in the last six months, he believes that consideration should be given to introducing additional reports, such as weekly or even daily cash reports, on top of the usual liquidity planning, in order to avoid sudden unpleasant surprises.

“Segmentation into immediately available cash and funds, which only take a few weeks or even months to become available, is essential,” he argues. “If critical time-windows are identified, they must be secured with suitable measures, for example by increasing credit lines or optimising cross-border cash pooling by adding further Group companies.”

For Parvez, short-and medium-term cash flows are key priorities now. “This is extremely important, so companies can continue to meet not only their day-to-day operational requirements but also their funding needs for at least a year,” he advises.

With markets still trying to contain the coronavirus and some seeing a spike and reintroducing lockdown measures, he believes we will continue to see a slowdown in economies globally. “In order to operate in these times, treasurers should take into account various factors such as purpose of the cash, time horizon and review their liquidity strategy to ensure they are equipped with sufficient cash to ride through the current situation.” Segmentation may indeed be a welcome case of divide and rule.