Risk Management

Understanding your cash flows

Published: Jan 2014
Small Waterfall in Autumn

Cash flow forecasting has long been a pain point for corporates. In this Back to Basics article, Treasury Today canvasses the experts for top tips to take the pain away.

Year after year corporate treasurers identify cash flow forecasting as one of the top areas in need of improvement. In Treasury Today’s European Corporate Treasury Benchmarking Study in 2012, it was ranked as the third priority, behind cash management/pooling structures and banking relationships.

But what makes it so difficult? A group treasurer at a Middle Eastern airline focuses on the complexity of the task due to the variability in the amounts, currencies and timing of business cash flows, as well as the impact of unpredictable changes in market prices for commodities (eg oil and fuel prices), exchange rates and interest rates. Many treasuries struggle with forecasting in countries where there are strict foreign exchange (FX) controls. In addition, there are more intrinsic issues related to the business, its infrastructure, organisation and geographical spread.

With a myriad of different technology systems and applications, including accounting, treasury management systems (TMS), enterprise resource planning (ERP), spreadsheets and emails, having a consistent and integrated view across the company is a significant challenge. According to Joerg Wiemer, CEO of Treasury Intelligence Solutions (TIS) and a treasurer for 12 years previously: “Even the questions ‘how much cash does the company have?’ or ‘what is the cash flow over the past six months in a certain subsidiary, currency or customer?’ can be extremely difficult for a treasurer to answer. This is because of multiple ERP systems, data sources, the thousands of customers and hundreds of bank accounts that contain the information needed for forecasting analysis. The first step to accurate forecasting is to establish a single source of truth.”

Lisa Rossi, Managing Director and Global Head of Structured Liquidity Products (SLP) for Global Transaction Banking at Deutsche Bank, agrees: “Treasurers use spreadsheets and emails to share data, which creates a disjointed view between actual and forecasted positions, and does not provide for a seamless flow of information. If you don’t have a complete picture or full transparency how can you undertake solid cash forecasting?”

The infrastructure challenge may be tough, but so are the internal organisational hurdles. Brian Titus, Treasury Cash Analyst at global brewer SABMiller, says: “It is a challenge to make colleagues understand what information you need for forecasting. Sometimes they don’t fully comprehend the bigger picture and how important it is to get that information.” This isn’t helped, he adds, by a wide geographic spread which can affect the timing of the data. “If the data is out of date, it is less reliable.”

Relying on information sent by others is the main problem, according to Paul Stheeman, ex-treasurer and currently an independent consultant. “The difficulty for a treasurer is that they are not 100% in control of the numbers and are effectively relying on information provided by others. They need others to send good quality data on time and in the correct format.”

Is the gain worth the pain?

Despite the level of difficulty, a reliable and trusted cash flow forecast is hotly sought-after and is considered to be a key performance indicator (KPI) for treasury. Respondents to Treasury Today’s European Corporate Treasury Benchmarking Study 2012 indicated that it was the number one KPI for core cash management efficiency and liquidity management.

Forecasting can also be the shareholders’ principal metric. Stheeman says, “I became aware of this in the private equity world, where I have been active during the past few years. Cash flow forecasting is the first metric they look at. More important than EBITDA numbers, it is the cash that they are interested in.”

For the Middle East group treasurer, an accurate forecast allows a company to be proactive in preparing for liquidity issues, as opposed to reacting to them. “This can have a significant impact on working capital costs, such as improved return on excess cash or lower funding cost on drawn facilities. In addition, it instils discipline and maintains a focus on cash throughout the business.”

Titus agrees, adding: “In the short term, it is all about cash management and ensuring that we have the right currency in the right place. If our forecast is not up-to-date, it may mean we have to go to the spot market and swap currencies when we could have planned it better. The long-term view is all about liquidity risk and whether we have covered our funding gap one or two years out.” Even though SABMiller can obtain a decent fixed interest rate at the moment, this won’t always be the case and therefore cash forecasting will only gain in importance for the company. His colleague, Alan Chitty, Treasury Controller, adds that with better forecasting, companies can also pay short-term debts back earlier and save money that way.

Successful liquidity planning, including analysing the gap between actual and forecasting, helps to better manage the company, according to Wiemer. “This will allow the treasurer to position their team as a business partner to the CFO because finally they can help the CFO to better manage the whole company. It is not just about better working capital management or optimising financial results, but also determining how important certain customers or suppliers are to the company.”

Both Deutsche Bank’s Rossi and Nancy Pierce, Senior Vice President (SVP) and Manager of the Capital One Bank’s Treasury Management Product Management Group, touched on the importance of good cash flow forecasting in risk management. As Rossi explains: “A lack of information can create blind spots – nobody wants blind spots when managing cash.”

Pierce talks of one client who used cash flow forecasting as a risk mitigation tool during the financial crisis. When a large proportion of the company’s lending froze up, treasury had to find other sources of funding. The company had a TMS in place but realised that it was only using about 10% of its functionality, mainly as an operating system for payments and receivables. Treasury worked with the software vendor on a project to reap the benefits of its technology much more broadly.

In addition, treasury put processes in place across the company to ensure that all the subsidiaries were using the tool and knew what they needed to input, as well as the proper controls around accuracy. It also switched to a more regional-based treasury structure so that all its subsidiaries were close to a centre of excellence. As a result, treasury was able to find trapped cash throughout the company that could help with its current commitments. That enabled it to alter the balance between bank funding and utilising internal cash. “It’s a great story of what this company accomplished in an urgent situation – it was able to marshal its forces and get it done quickly,” says Pierce.

Tools for improvement

Technology plays a critical role in forecasting, but it is also a question of process governance, according to Wiemer. TIS’ cloud-based platform, which is delivered as a software-as-a-service (SaaS) solution, includes a governance module which helps to define data collection and aggregation processes. “These need to be automated and streamlined,” says Wiemer. “Although it is possible in theory to roll out a treasury guideline and try to get people in a local subsidiary to stick to your rules, in real life they probably won’t even read them. This is why you need to roll out governance processes and technology as well. For example, TIS technology provides a step-by-step workflow that the local staff need to go through in data collection.”

Governance is hindered in many ways by the prevalence of spreadsheet usage in companies of all sizes. Christian Mnich Director Solution Management – Treasury Applications at SAP AG, spoke of a client that previously used an Excel spreadsheet globally – its subsidiaries access the spreadsheet on a single server and create rolling forecasts for the coming 12 months: “They struggled with the spreadsheet because they couldn’t see which subsidiary has already submitted a forecast or if someone has altered it.”

A client of Deutsche Bank used multiple spreadsheets to forecast their overall position, with subsidiaries sending cash updates via email on a weekly basis. The data would then have to be consolidated and evaluated. By using Autobahn’s Liquidity Manager app, the treasurer was able to take all account information, segmented in a way the team could understand and analyse so that each subsidiary’s account information was easily visible. “This meant he could see how effective their daily planning schedule was against actual payment flows – the system has a reconciliation tool that can match cash receipts and payments,” explains Rossi.

The platform also has an investment dashboard to monitor the company’s overall investment position. This allows the treasurer to understand their liquidity profile in addition to the allocation of counterparty risk, which are both important. Therefore, if a particular event is pending where he needs more funding, the treasurer can easily see where and when funding was available and accessible.

Interestingly, despite implementing a new TMS globally SABMiller still relies on spreadsheets for capturing forecasts but they have been able to significantly improve its cash flow forecasting. As part of its ongoing ‘Project Griffin’, SABMiller rolled out IT2 NET, which is a remote, browser-based solution, around the regions. The majority of the subsidiaries’ forecasts come into IT2 NET through a pre-determined spreadsheet which looks and feels the same business-to-business. The treasury team was able to construct the spreadsheet’s rules and logic, and also prompts in terms of data ranges. Treasury also has macros embedded, so that it can pull specific information. The spreadsheet itself can’t be incorrectly uploaded into IT2 NET, so it is a combination of “an easy spreadsheet for people to use, reflecting what they are already accustomed to, and more controls over that information before it is imported into the IT2 system,” says Chitty.

“We could have gone down the route where they plug the numbers directly into IT2 NET screens, but in reality they would just be using their own spreadsheets, taking the numbers out and typing them in, which could introduce transposition errors. Therefore, we decided to let them use spreadsheets but have greater control over them,” he adds.

It is clear that both processes and technology are critical components of improving cash flow forecasting, but where do the banks come in? A number of banks say that the answer lies in their proprietary electronic banking (e-banking) systems, but many corporates are looking to be more bank-agnostic in their relationships. Robert Pehrson, Global Head of Liquidity Products, SEB, says that the most important thing that a bank can bring to the table is experience from other clients. “We too have a tool that supports the forecasting process. However, the tool itself is not the major benefit for the customer but the knowledge that we have built up working with other corporates.”

One of the first clients SEB worked with didn’t have centralised forecasting at the beginning. Today, the company has a daily process in place – by 8am it has a consolidated view of the balances for all subsidiaries, approximately 300-400 accounts. It also has daily, weekly and monthly forecasts. “This means they can act during the day on securing positions based on reliable data,” says Pehrson. “They also developed a rigid follow-up process for subsidiaries that don’t report according to plan. This is extremely important to give feedback to subsidiaries that might report late or with poor quality information. They have also put in place KPIs so that the subsidiaries are given an incentive to improve their information.”

Top ten tips to better forecasting

When asked their advice on how to achieve better accuracy in cash flow forecasting, the experts interviewed for this article were not short of comment. Here are some of their top tips.

  1. Use technology to your advantage

    As SABMiller’s Chitty says: “You must embrace your technology and make it work for you”. Technology is a great enabler, but it must be calibrated for your organisation; according to Capital One’s Pierce, “you could have a lot of power there that isn’t used.”

  2. Integrate your systems

    Once you have the technology in place, the systems need to be able to speak to one another. “Integration plays a major role, so the more operational systems you can integrate as sources the better the forecast will be,” says SAP’s Mnich.

  3. Automate as much as possible

    Almost everyone touched on this. The Middle East group treasurer comments: “Make sure you are able to obtain cash balances daily for all accounts in as automated a way as possible. This starting point forms the basis for forecasts.”

  4. Define your terminology

    This starts with specifying the difference between short-, medium- and long-term forecasts and defining their parameters and usage. Nomenclature and formats are also critical, as well as a definition of global liquidity, which “shouldn’t be underestimated in terms of effort,” says Mnich.

  5. Develop and standardise processes

    “This relates to your internal information flows and accuracy, and people’s willingness and ability to follow the corporate practices and policies that are key,” says Pierce. “It is important to standardise processes and make sure your subsidiaries are all following the same practices and are able to capture the data needed for analysis.”

  6. Build internal relationships

    The Middle East group treasurer suggests working closely with planning and budgeting to make sure both P/L and cash perspectives are understood and generated. In addition, build a close relationship with the big spenders in the business and set up a process to get their updated cash forecasts.

  7. Get buy-in from top management

    “Very often people preparing cash flow forecasting at operations level consider this to be just another task that they have to do every week or however often you require it. To have CFO buy-in helps underscore the importance of cash flow forecasting. Otherwise people won’t be properly engaged,” says Stheeman.

  8. Feedback

    It is important to go back to the subsidiaries with feedback as to how accurate it was and build in some KPIs into the process. “Over time you can view how well or how poorly they have done,” says SABMiller’s Titus. “That is the area we are looking into next – now that our colleagues are used to the process, it is all about improving it and having a KPI measure attached to it.”

  9. Make people accountable

    Both Stheeman and Chitty advise making people accountable for forecasting, so that they actually make an effort with this. “If it just becomes a cut and paste job then people can quite easily carry forward mistakes,” says Chitty.

  10. Communicate, communicate, communicate

    Although everyone touched on this point, Stheeman succinctly says: “Let everyone know what you are doing and its importance. Don’t roll out something and just say ‘this is our new cash flow forecasting tool, use it as of next week’. Make an effort to visit and educate the subsidiaries and business units.”“People often talk about cash flow forecasting, and with Basel III and banks being more strategic about balance sheet, funding costs will be under even greater pressure. It is time that we stop analysing cash flow forecasting, and instead grab the bull by the horns and just apply good cash forecasting techniques using progressive technology,” says Rossi.

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