In the course of the financial crisis, liquidity and foreign exchange (FX) risk management have been identified by many corporates as weak spots that need significant improvement. Specifically, companies have realised that they do not have the right kind and quality of information at their disposal to make risks transparent in a timely fashion and manage these risks effectively. Many treasurers are therefore looking to improve their planning processes and close the gaps that have been – often painfully – exposed during the crisis. Cash flow is in the spotlight more than ever, as companies strive to avoid funding shortages, investors focus on cash flow metrics in the absence of meaningful profits, and rating agencies look for liquidity risk metrics to guide their rating actions.
Results from the recent cash management survey published by gtnews on 20 October 2009 underpin this notion. A staggering 31.3% of respondents state that cash flow forecasting is the treasury process where greatest improvement is needed. That’s no surprise, as 67% of companies say they still use spreadsheets for cash flow forecasting. Even those 20% of respondents that claim not to be managing the cash forecasting process at all will likely have been prompted to re-think their attitude during the crisis, which has shown that even financially sound companies may well encounter difficulties when trying to raise funding in turbulent markets. Interestingly, 50% of respondents say that lack of systems integration is a key stumbling block for efficient cash flow planning, 23.6% point to inefficient processes at the subsidiary level, and 35.8% identify limited availability of resources as a problem.
Greater Transparency is Needed
In our client engagements we have witnessed first hand how companies have had difficulties during the crisis to obtain the information required to manage cash flows through market turmoil. Top management put detailed questions regarding cash flows that had not been deemed relevant before, when profit was the all-important consideration, top of the agenda, and treasury needed to provide answers. Where a single cash flow figure per group company had been considered sufficient in the past, decision makers now wanted:
- To know exactly where in the company cash flows are generated and what business activity causes them.
- To analyse what the drivers of those cash flows are and how those drivers can be influenced.
- To evaluate how different business scenarios play out in terms of cash flows.
- Powerful reporting with drill-down capabilities and easy-to-use management dashboards.
- One single source of cash flow information for the entire company.
Obviously, such requirements cannot be met by a spreadsheet-based planning process because it has a wide array of deficiencies:
- It takes too long, requires non-value add manual work, and is error-prone. In times of increased cost pressure, it is better to use your headcount for value-add analysis and decision making tasks than for compiling spreadsheets. Quicker turnarounds are also a key advantage.
- No system support with data aggregation, plausibility and consistency checks, scenario analysis, and reporting and analysis. Overall, this means that the process is excessively lengthy and generates results that lend themselves badly to further analysis, which is where the real value-add occurs. Furthermore, it is difficult to keep a consistent view of historical data when spreadsheets are used.
- No transparency as to where data comes from, what data actually represents, what is in and what is not. You’re much better off establishing a common ground for cash flow planning once and for all by providing basis data from upstream systems, establishing standardised templates, and implementing an intelligent process that allows planners to get rid of their complex spreadsheet models. This will spare you endless follow-up calls with planners to find out how they arrived at their numbers.
Integrated Cash Flow Planning
The manual planning process that we know all too well needs to be replaced. We believe that to tackle the challenges mentioned above, a system-based, integrated cash flow planning process is the way to go for treasurers. Implementing a planning process, like the one shown in the figure below, will achieve the transparency they need to thoroughly understand and actively manage cash flows and FX risks that arise from the operating, investing and financing activities of their company.
This process uses data from upstream corporate planning systems (which facilitates data generation and ensures all planners start from a common basis), allows local planners to contribute their knowledge in an efficient manner (which improves the communication between local and central entities), and provides a standardised end-to-end process and system platform for all stakeholders. By leveraging such a solution, treasury employees can focus on analysing and managing cash flows instead of aggregating Excel spreadsheets and fixing broken cell references. Through a routine feedback loop, analysis results will directly contribute to enhancing the process for the next planning cycle, resulting in continuous process improvement and, ultimately, better planning quality.
Enhanced Cash Flow Planning
While a new automated planning process per se may not solve the problem of limited resources, it may well serve to direct available resources towards more value-adding activities. By using existing staff resources more efficiently, treasury can generate more value-add and enhance its strategic importance as an advisor to top management. The following features and benefits of integrated cash flow planning are worth highlighting in greater detail:
- Rolling planning in transaction currency for all relevant group companies gives you cash flow visibility well beyond year-end (typically 12-24 months depending on business model) and allows you proactively to manage liquidity and foreign currency risks that go hand in hand with cash flows.
- Planning according to the direct method at a meaningful level of detail is essential to gain insight into how cash is generated and how it is used. It enables you to ask the right questions in case of follow-ups, and thus allows you to manage cash flows better. Ultimately, your information needs determine the data structure required, but the way the data is generated needs to be taken into account as well. Equally essential in determining the data structure is the granularity in which actuals can be provided.
- Upstream systems integration establishes transparency about the drivers of cash flows and ties back the cash flow plan to essential corporate plans, such as profit and loss (P&L) and sales planning. Integration into enterprise resource planning (ERP) and treasury management systems is also advisable. You need this information to understand how your cash flows are generated, which will tell you which levers you need to pull in order to manage them. After all, you can only manage what you understand.
- Increased planning quality and up-to-date planning data through streamlined, standardised process for data generation. Based on upstream system data, planning functions will assist planners in transforming corporate planning data (e.g. sales planning, production planning, P&L, capital expenditure planning) into cash flows. This allows you to tie back cash flows to corporate plans in a transparent way and at the same time gather crucial input from the field. Intelligent versioning offers insight into the data generation process and supports analysis. This fosters a constant feedback loop, where planning quality is tracked consistently and any issues are followed up on in an effort of continuous process improvement.
- An end-to-end process brings together all stakeholders. Local planners at the operating level contribute their know-how and can comment on the data. Data from corporate planning processes based on common premises is used, key parameters allow for quick data validation. Once free cash flows for the period are planned, treasury can use the data to plan intercompany funding, trigger appropriate action on the capital markets and manage FX risk. Finally, the management team is able to base its decisions on a complete set of operating, investing, and financing cash flows for the planning period. Effectively, you have created a single platform for all people concerned with cash flows in your company.
- Actuals serve as the ultimate benchmark for planning quality and provide insight into the drivers of realised cash flows. Such information is a key prerequisite for improving planning quality, and its information content is far superior to what plan-plan comparisons can provide. Direct method cash flow planning therefore needs to be supplemented by a method of automatically gathering actuals in order to bring visibility into the realised cash flow patterns of the company. Some treasures will even argue that actuals need to be understood before planning efforts should be undertaken.
- Significant value-add through analysis and reporting. Flexible reporting of plan-plan and plan-actuals data enables in-depth analysis and fosters understanding of cash flow drivers, which can guide management decisions. It is key that easy-to-use web reporting is available to all stakeholders at their fingertips. As more and more companies move from rigid planning cycles to scenario-based planning approaches, capabilities for scenario analysis provide crucial decision-making support.
- Output made available to downstream processes. Interfaces can be used to provide cash flow data to downstream systems, such as treasury management systems and risk management applications. This way, for example, cash flow planning data can feed into cash flow at risk simulations and provide the basis for the cash flow hedging of foreign currency risks.
An Iterative Implementation Approach
Some may believe that although this is all well and good, such a project will be expensive and time-consuming – do not despair. We recommend an iterative solution approach that will first realise the most essential benefits – standardisation, avoidance of errors, automated aggregation and improved reporting – through the implementation of a simple web-based data collection and reporting solution. This establishes a common cash flow information platform for all stakeholders quickly (around six months) with a manageable effort in terms of time and money.
As a web-based solution, a global roll-out will not require significant IT outlays. Rather, the focus will be on user training regarding the new business requirements for cash flow planning. Our experience shows that once the first planning rounds with the new tool have been carried out and the process has been established, there demand for increased functionalities along the lines of systems integration, planning functions for data generation, scenario analysis, enhanced reporting, and the generation of input for risk management, from FX to cash flow at risk, will quickly increase. Laying the ground with a quick-win solution, is, in our view, the ideal way to obtain management attention and buy-in, educate users on cash flow planning, and build a solid basis for a more elaborate strategic planning process on the same platform.
The past few years have shown that high-quality cash flow planning is a necessity for all companies. Not only does timely arrangement of funding and selecting the right maturity structure save interest expense and contributes to optimising investment income, it is also an essential risk management tool to steer through turbulent markets where credit is scarce and being unprepared can be costly for the company at best, lethal at worst. Increasingly, financial market participants demand cash flow data to assess a company’s viability and credit rating. Consequently, cash flow has become a key financial indicator that meets renewed interest at many companies. Treasurers need to rise to those challenges and implement an integrated cash flow planning process that allows them not only to explain existing cash flow patterns but to increase visibility by extending the planning horizon and actively manage cash flows, thereby avoiding any liquidity shortage that may arise.
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