How Treasury Can Set Standards and Steer the Business

 

by Carosin Buitendag B.Com.MBL, Group Treasurer, DAWN Limited, Co-founder, Powerstrat and Terence Kades B.Soc.Sc.MBA PMP, CEO and Co-founder, Powerstrat. CEO Blue Wave BI Decision Tools 

The treasury is the steward of cash, and cash like oxygen, should be harnessed, not wasted, and used to support the most profitable business products, services and growth opportunities. In a literal sense we recognise the cash we hold in our hands, but when we manage cash we also manage proxy cash™ and this is what separates the professionals from the novices and where it gets interesting to demonstrate what treasurers could be.

Expand the definitions that hold treasury back

To release the opportunities for treasuries to play a wider role in support of the business, one needs to look at definitions that might be holding treasury back from creating additional value and added services. Let’s consider two obvious candidates; cash flow analysis and cash flow forecasting. 

Cash flow is often confused with cash management and this is a real issue. Fortunately it is easily resolved because it’s a matter of amending the definitions to throw light on the expanded treasury opportunities. Cash management is about managing short-term cash, typically the daily cash inflows and outflows up to a three-month forecast window. This is an extremely important view of the cash because it keeps the doors open for business. But what is this view? Mostly it’s the results, meaning that it is the daily flows extrapolated, such as cash sales, money in the various bank accounts, investments in various cash and near cash accounts, debtors and creditors due in the short term. This is a limited view because it excludes many other important parts of a funding model. 

Cash flow forecasting is another area of confusion which also relies on the view of how cash is defined. If cash is defined in a cash management sense such as cash sales, money in the various bank accounts, investments in various cash and near cash accounts, debtors and creditors due in the short term then that is what will form the basis for budgets and forecasts. While important for treasury, it is a rather narrow view of what should be included in a forecast at a higher level or longer term i.e., from 3 months to 24 months and beyond. It is important because it shows what is expected in the future, which influences many important KPIs of both operations and cash flow management. 

A funding model view of cash flow 

Let’s consider how using the elements of proxy cash can be put into practice helping the treasury to guide the business from a cash perspective. First we tag those accounts that are cash and those that are some distance from actual cash (banknotes) which we term proxy cash. Business units work with proxy cash on a daily basis, e.g., inventory, debtors, creditors, interest paid and received, Capex, intercompany debtors and creditors, intercompany financing, forex, and so on. Grouping these accounts under logical headings or categories provides the foundation of a method for a treasury manager to help business units better understand the cash implications of their business.

Our work and research over the past 25 years in both private and public sector organisations has highlighted certain critical elements in the management of cash. This is not about daily cash management. Proxy cash takes different forms because management has varying needs and perspectives. Cash can exist in many forms, from actual cash in the pocket to cash in the bank, lines of credit, loans available or owning, bonds, to inventory, debtors and creditors. We term anything that is not near cash as proxy cash. Proxy cash shows in the transaction accounting systems and is mixed with accrual type accounts. To better understand and manage the continuum of cash, we need to select valid proxy cash accounts that reflect as close in proximity to cash as possible. This is the subject of our Funding Model discussed in this article. The Funding Model categories are shown in Figure 1  [see page 2].

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Figure 1 shows the fourteen categories in the Funding Model at the parent level. Some parents in the diagram also have children giving a total of thirty-eight ‘child’ accounts. The model is comprehensive to accommodate all cash related items, but not all of these apply to all businesses and should therefore be customised to suit each one individually. Using this method we also devised a method encapsulated in a software tool to show leakages in cash as well as identify cash that is trapped. This means that a great amount of detailed data can be analysed, forecast and used to assist management in decision-making that relates to cash as well as their KPIs.

 

Fig 1 – Categories in the Funding Model

The Funding Model is populated by the business units either from the accounting system or directly into an Excel template which is automatically consolidated by the CFO or treasury. We have developed a software tool called Cash-I that automates this. The Funding Model provides several benefits:

• It shows different data views such as actual, budget, rolling-forecast and forecast data. 
  
  
• It is useful to all stakeholders. For management, it shows all the sources of cash and all the movements and outflows of cash. 
  
  
• For providers of finance, it shows an entire cash picture of the business and quickly highlights leakages and potential problem areas.
  
  
• It provides an extended format for new ratios that focus on cash and liquidity risk. 
  
  
• It provides the basis of graphic views that show a clearer cash- focused picture in a business.
  
  
• Understanding cash in its entirety paves the way to improved cash management, lower liquidity risk, and better control of the important parts of the business.
  
  

 With this amount of detail, the treasury will have provided a common cash flow language within the group for the CFO and the business units, which is valuable because it allows the business to be consolidated and analysed with consistency from a cash perspective. 

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Innovative cash flow forecasting beyond money management 

Treasury can or should set the standards for cash flow forecasts, ensuring that one common language is used throughout the group. There are a few important considerations relating to forecasts. First is that they should be reliable, and second that they are understandable. Those relying on the forecast values should understand the logic of the statistics. Thirdly, it is vital that people should have clear sight of and be able to understand the business and economic drivers behind a forecast. Unfortunately, although this should be obvious, it is rare. Advanced statistical techniques are only as good as the data on which they are based. The problem is that these forecasts are usually controlled by statisticians, and other people in the organisation do not understand the statistical methods and are not easily able to see the business or economic drivers behind the forecasts. A lack of understanding means that buy-in is limited and this this opens the gate to organisational politics and games. 

Using the power of latest software coding technology, we devised an innovative forecasting method that has proved reliable and possesses the characteristics required by all stakeholders.

Economic and business driver cash flow forecasts

We found that cash flow forecasts and modelling based on economic drivers is an intuitively logical, easy to understand and very useful concept. A set of economic drivers is selected and each driver is weighted for its importance. For example one might choose Bank Prime Rate, GDP growth, Inflation, FX rates (e.g., US$ - euro and yen) relevant commodity prices and so, on but these should be limited to the critical economic drivers. This is usually done by each business to keep it in context, and it differs by country and industry. The next step is to apply this basket of economic indicators to the various line items in the Funding Model that drive cash flow, such as cash sales and all the different inflows, debtors, non-operational flows and expected CAPEX outflows. We run this on a monthly basis for the desired period of the forecast - usually 2 to 15 years. The tools we have developed do this quite quickly and once the process has been set up even a 20- year forecast can be created within a few minutes. 

Scenarios, assumptions and stress testing for uncertainty

Scenarios provide upper and lower boundaries or bands. The terms High Road and Low Road and Expected Road are familiar scenario descriptions. Cash flow and liquidity forecasts facilitate business planning in a more formal and repeatable structure, which is useful for executives, managers and providers of finance. Usually the High Road is a 5% increase over the Expected Road and the Low Road is 12 – 15 % decrease from the Expected Road. This method allows individual economic drivers to be varied within the increase or decrease. 

Managing liquidity risk and sustainability

The start to managing risk is to identify and understand the different types of liquidity and cash flow related risks in a business. It is not uncommon that the analysis and management of cash flow and working capital is inefficient for various reasons, e.g., skills or time shortage, managed in silos where departments do not communicate enough, or simply poor management . An example is that business units may take creditor discounts for early settlement which might be far more costly than other forms of finance available. If there is a liquidity squeeze then early settlement discounts should temporarily give way to finding cash even at a higher cost.

We have developed an interesting tool termed the Naked Cash-flow Model that shows the sustainability and viability of a business purely from a cash point of view. This naked cash flow model uses eight dimensions including sales, purchases, inventory, debtors, creditors, cash surplus and gross profit. It graphically depicts the business model of a single business unit at a time (not consolidated view) based on budget or forecast figures. It is interesting to see that management might believe they have a good business plan, but when they look at it through a cash lens, it is not what they intended. Treasury should lead the naked cash flow analysis and assess each business using this model.

 

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Summary

Opportunities exist for the treasury to expand its usefulness to the business in a group by the following actions:

Provide a policy manual that deals with all the elements, the accounts that fall under the term cash flow. Include guidance on analysis of cash flow and acceptable ratios and KPIs by industry, and include minimum thresholds acceptable within the group. Also show the exact arithmetic for calculating each item in the cash flow policy manual. 

Provide cash flow Funding Model templates and require BUs to provide monthly data with their actual and revised or rolling forecasts. The reason is that this forces the business to look at things with this perspective and better understand the cash implications of their business.

Make your treasury hands-on by guiding all the business in the group, and show how small things like settlement discounts should be evaluated because they could be wasting cash, or have other implications such as stressing liquidity. 

Use technology that helps to make this easy and meaningful for the BUs and the group. Use more up to date techniques than Excel, because the complexity and the risk (e.g., mis-referencing cells) can stifle the analytical growth needed to build to a modern value-added treasury. Be freed from complexity so you can focus on what matters.

 

Carosin Buitendag B.Com. MBL. Group Treasurer, DAWN Limited Carosin is a co-founder of PowerStrat Liquidity Management Solutions. She is the Group Treasurer of the public company DAWN Limited, and has been working in the treasury environment for over thirty years in both public and private sectors. She is an expert in cash flow and liquidity risk management, and having developed numerous solutions for cash flow forecasting and funding models, she saw the opportunity to develop a liquidity management toolset now marketed as PowerStrat Cash-I.  [email protected]

 

Terence (Terry) Kades B.Soc.Sc. MBA PMP. CEO and Co-founder, Powerstrat. CEO Blue Wave BI Decision Tools.  Terry has spent most of his career in management consulting and designing intelligent software tools that link business, marketing and strategy with finance and risk. He co-founded Powerstrat Liquidity Management Solutions and helped design and run the development of the Cash-I. He now implements, trains and consults with Cash-I in cashflow and liquidity risk management, customer profitability and product profitability and pipeline management.  For further information please contact [email protected] Tel. + 27 79-367-9036