Cash & Liquidity Management

Life in the balance

Published: Nov 2013

Stack of coins

When the market place is squeezed, the level of competition amongst businesses is ratcheted up to even greater intensity. The creative energies in a company have to deliver the right goods or services, the sales people have to pull out all the stops, and production has to seek ever greater efficiencies. But it all comes to nothing unless the financial team, and particularly the treasury, take their game to a new level too because if the business runs out of money – even if on paper it is making a profit – it is the end of the game. Nowhere is this more evident than in the small and medium-sized enterprise (SME) community and the mid-market enterprises (MMEs), where capital buffers are often less well established and the market for funding is tight, if it is available at all.

Cash management, and in particular the efficient management of working capital, therefore can stand between success and failure for many smaller firms. Accounts receivable (AR) is the major source of working capital, which in essence is the money needed to carry out day-to-day financial operations derived from the difference between current assets and current liabilities (a major outgoing, of course, being accounts payable (AP)).

But proper cash management is more than just optimising the payments and collections cycle; it also demands a thorough consideration of a host of essential liquidity management processes such as forecasting, short-term investments, funding and foreign exchange (FX) management, as well as technology and regulation and taxation, and of course managing bank relationships.

The AR challenge

Forty-one percent of firms surveyed in a recent American Express Global Corporate Payments survey said that their customers often pay late. “Clearly, this has a significant impact on cash flow and a company’s ability to effectively manage its working capital, as well, of course, as having a detrimental impact on an organisation’s relationship with impacted suppliers,” says Brendan Walsh, Senior Vice President (SVP), American Express Global Corporate Payments Europe. “Many businesses are using a combination of payment solutions and tools to try and improve their cash flow – from working capital loans to customer discounts for early payment.” However, he claims, when implemented, a number of these can be detrimental to the supplier, eroding the value of the payment considerably.

His suggestion, naturally, is to implement a card programme, where companies are essentially outsourcing the payment dimension of their supplier relationship. Beyond the obvious bias, Walsh makes the valid point that such an arrangement can help smaller businesses because the card company processes payments with the supplier, typically making payments after five days, “which of course is far earlier than payment via the traditional invoice system that typically sees suppliers paid at any time between 30 and 90 days”.

Walsh further points out that SMEs should be thinking about how they manage and forecast expenses in order to gain full visibility of where company cash is going. “Detailed reporting makes forecasting easier and helps businesses to see where costs can be consolidated, putting them in a far stronger position to negotiate with key suppliers,” he states. In addition, it enables companies to identify negative trends quickly, enabling them to take corrective action and ultimately free up funds.

A shining example

For a smaller business to survive let alone thrive in this economy, it is clear that it needs a set of well-defined cash management processes. Some smaller corporates excel at this. Hollister Incorporated, an independently-owned US-based global company that develops, manufactures and markets healthcare products for sale across 90 countries, is a prime example.

Sheila Johnson, Vice President and Treasurer, classifies the company as “middle-market sized”. Even so, according to a highly experienced client manager at Bank of America Merrill Lynch (BofAML), “Hollister’s treasury operation is the most disciplined I have ever seen – anywhere.” It is some claim, but Johnson and her team were Highly Commended in the Best MME/SME Treasury Solution category of the 2013 Treasury Today Adam Smith Awards.

So, do the pressures of managing cash differ for a player in SME/MME space from those of a larger business? “I would expect some of the considerations to be the same across companies of all sizes,” says Johnson. “Potential differences could exist in how companies raise capital through public markets, bank credit facilities or through internal funding,” she notes, but adds that the Hollister treasury goal is traditional in that it seeks to provide confidence to the Board and enable the company to implement its investment strategy. “We have business cycles that require differing levels of liquidity. We also need to consider the location of cash and the funding requirement to determine if repatriation is required.”

To facilitate this, cash flow and forecasting has always had a disciplined planning process in Hollister. But over the past few years the treasury team has focused on enhancing these aspects; this is where the company may mark out the difference between itself and other smaller and mid-market players. The fact that the current economic crisis has not deflected Hollister from its goal certainly indicates treasury’s resolve.

“We have maintained similar investment objectives and practices for many years,” states Johnson. “But the emphasis over the past five years has been to gain visibility of and access to all cash, globally.” This required the firm to allocate staff to build a global banking platform. Treasury has consolidated its banking partners and by doing so Johnson says it has been able to improve the quality of relationships and the service provided to it. It has also created an inter-company netting process and established notional pooling structures for euro and sterling transactions. The goal is clear: from a cash perspective, the team is aiming for 100% visibility; today it is already well above 90%.

On the P&L side, it has implemented SAP’s Business Objects business intelligence system for planning and consolidation, with the Oracle Hyperion Strategic Finance tool providing a seamless interface with P&L input. “We leverage our SAP Treasury platform as the hub of our treasury technology platform,” says Johnson. The company links global banking, FX trading and netting platforms to SAP Treasury to streamline processing “as much as possible”.

“Managing working capital is an important initiative for our company,” states Johnson. “Treasury takes a leadership role in managing the working capital committee and utilising working capital levers to benefit the company’s liquidity position.”

Preparing the ground

Getting to this state of preparedness is no accident and Lothar Meenen, Deutsche Bank’s Head of Trade Finance/Cash Management Corporates for Germany, has seen at close quarters how cash management skills within smaller businesses can draw a line between success and failure. “SMEs in many cases do not have the opportunity like the large corporates, to maintain state-of-the-art treasury centres or outsourced shared service centres (SSCs),” he says. Without the economies of scale or the complex technological infrastructure, these businesses may struggle to follow the same path as their blue chip counterparts.

In addition, many smaller firms will not necessarily have the broad sweep of internal cash management skills to be able to exercise financial control. As such, Stuart Bailey, Head of Products for SMEs at Lloyds Bank, notes that the core concerns of the smaller business will typically be “simplicity, transparency and timeliness”. This, he says, often leads to a call for help to the banking community.

Of course, selecting the right banking partner thus becomes ever more important for the SME. When in selection mode, the process is quite different from that of the large corporate. The latter will often look to multiple banks to provide the balance sheet before deciding what proportion of its total wallet it will assign to its final panel. For the SME, it is more about assessing if a bank has the right product set and whether it will be a reliable partner because this sector is often looking for a provider with a “comprehensive proposition”, says Bailey “in terms of the relationship, provision of credit and core banking services”.

There is a high degree of trust required in the relationship and this, he adds, must be demonstrated through the strength and quality of the bank/client relationship where the bank will support the client through its lifecycle, not just on a moment-by-moment approach. There must also be “absolute clarity” of communication, especially around billing, the return achieved on credit balances and the cost of funding. It is, he stresses, “incumbent upon banks to ensure the client understands the value that we are providing”.

Simplicity, speed, service but not always cost

The expectation might be that smaller businesses are driven almost entirely by cost. Meenen argues that whilst pricing is often a concern for large and multinational corporates it is not necessarily the case for SMEs. “Of course, they do look at price but I do not see the kind of cost pressure in the market we see from the larger companies.” Whilst SMEs are clearly not going to tolerate being over-charged, often they want flat fees because predictability assists with their forecasting and planning.

That said, Meenen believes large banks understand charging per-transaction can add up to a very expensive way of operating. If a smaller company can provide meaningful business across its total banking requirement, fee-structures can be reassessed especially, he notes, as parts of the SME sector are now looking increasingly attractive to some major institutions.

Another critical aspect, according to Bailey, is service; not just the skill and judgement of the relationship manager in offering the right products and services at the right time but also how well the bank steps up when additional services are required to support day-to-day banking and of course the ease with which contact with the right person can be made at any time. As well as being extremely service-demanding in terms of timeliness of delivery and individual attention, Nick Diamond, Head of Cash and Payment Sales, Commercial Banking, Lloyds Bank, believes the smaller corporate ultimately displays sensitivity to value.

Technology and consultancy

Corporates often use their banks in an advisory capacity, especially where internal resources are not available to manage long-term projects. Nowhere is this better illustrated than with the migration to the Single Euro Payments Area (SEPA). In Germany, for example, the Bundesbank requires its banking system to provide the SEPA format not just for cross-border payments, but for every payment. It is a major programme, but many SMEs are not at the right stage of preparation for the deadline; they have no project teams and no deep understanding, says Meenen. Deutsche Bank has carried out an in-depth study of its client base and most say they will be ready, with perhaps 10% opting to use third-party SEPA conversion services (Equens, Experian or CGI, for example) to avoid a breakdown in their payments flows. However, at a broader level of SEPA implementation, whether the wider community of corporate counterparties will be ready is another matter and this is why many institutions have rallied round their customers, establishing lobby groups and informal networks to share information.

SEPA is just one aspect of technology and banks and vendors can offer a range of sophisticated cash management tools. The main consideration for the SME is to understand what is the most appropriate technology at a given time and then to manage this through the growth cycle of the business. If, for example, a company is at a point where it is trading internationally, it may be easier to manage this through one domestic account. But if the exchange rates offered are not favourable, it may find it more prudent to set up a complementary series of local accounts and use the structured trade finance services of its bank (as well as its core working capital facilities). This means that the systems, architecture and services offered must be configurable and scalable to meet the changing needs of the client. It must also be proportionate to need – a cross-border pooling structure may be overkill. To this end, comments Meenen, “a bank needs to be honest and make that differentiation between what it can and cannot provide”.

Direct access to an online banking system may be sufficient for a small business – the smaller businesses will most likely deal with just one core bank – but as operational complexity is introduced, regular contact with a bank’s relationship managers is more likely to facilitate the bank’s understanding of its client’s progressive needs and enable it to provide the right services.

The number of cash management personnel may increase with the size of the business but in a small company the cash manager is likely also to undertake a number of other treasury-related roles. On the surface, says Diamond, this may seem like the ideal structure to reach the heart of the company’s needs quickly and have direct access to the decision-maker. “But the challenge can sometimes be the capacity, focus and priority of that decision-maker. We may wish to talk about a specific topic but they may have conflicting priorities; whilst we have to understand the client’s agenda, in a smaller company their own management of priorities is much more difficult than in a bigger organisation.”

Desirability of the SME as a bank client

Independent research published in April 2013 by the UK’s National Institute of Economic and Social Research has found that bank finance has become more difficult for SMEs to obtain following the financial crisis and, it notes, credit “has remained relatively difficult to obtain since, compared to the period before 2008”, and rejection rates for loans and overdrafts increased after 2008 and have not dropped back yet. The report also says “economic uncertainty appears to affect bank lending to SMEs disproportionately compared to large firms”.

This relates to the UK only but all the same suggests that smaller businesses are not in favour with the banks. Not so, says Meenen. He argues that the appeal of the smaller corporate for a large bank is very much alive and driven by the regulatory environment. Dealing only with the major corporates, he explains, arguably could make the banks slightly less stable, at least seen through the lens of Basel III and Capital Requirements Directive (CRD) IV which seek greater diversification and stability in the funding base of banks. SMEs provide one source of diversified funding which meets with regulatory approval.

“There has been an interesting trade-off between lending-growth, to ease us out of recession, and the deleveraging and liquidity and cash increasing in the market,” notes Bailey who adds that it will be interesting to see how this situation will play out. The past few years may have been difficult for a lot of businesses, but as growth returns (albeit very slowly) to some markets it will bring new challenges for the smaller business. One of the main issues, he believes, will be around working capital cycles because as the smaller business seeks to expand, the greater demand for their products will require increased funding of all the elements needed to meet that demand. For the treasurer of the smaller business, it seems a finely tuned balancing act focused on maintaining working capital and bank relationships is never off the agenda.

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