Published: January 01, 2011
Treasurers need to focus on the timing of a cash flow, rather than simply the value of the flow.
Since the financial crisis first struck, working capital management became one of the key topics on treasurers’ agenda, particularly as financing has become less accessible and more expensive for many companies. In reality, effective management of working capital is essential to a healthy business whatever the economic situation, including an efficient cash conversion cycle and the ability to forecast cash flow with confidence.
Ericsson has a group treasury function based in Sweden, with sub-units based in locations globally, including in South Africa, which is responsible for cash and treasury management activities across sub-Saharan Africa. Optimising working capital is an important aspect of the role of the regional treasury centre, particularly accelerating the cash conversion cycle.
Even though the economic situation is improving for many companies, with a greater emphasis on profitability rather than simply survival, treasurers need to remember that profit is not the same as cash flow. Even profitable businesses can run out of cash, particularly in an environment where liquidity is likely to remain scarce, which is one of the main reasons why a seemingly successful company will fold. To guard against this, treasurers need to focus on the timing of a cash flow, rather than simply the value of the flow. For a company with working capital challenges it is more important to collect cash as per forecast rather than a collection for a higher amount later. Consequently, there are three areas on which to focus in order to accelerate the cash flow cycle: the payment terms and conditions negotiated with suppliers; the lead time between purchase order and payment, and the credit period granted to customers. These issues are typically outside treasurers’ hands, so it is vital to communicate clearly with business and project managers how commercial terms agreed with both suppliers and customers, as well as the efficiency of internal processes, contributes to the financial health of the business. Issues such as complex acceptance criteria, payment postponements caused by project delays outside of the company’s control and change requests that have not been properly scoped can all affect not only the amount that a customer is paying, but also the timing (figure 1).
Having examined our cash conversion cycle in detail at Ericsson, we have embarked on a project to elevate the importance of collections within the business. There are many different elements to this. For example, while account managers and project managers have direct interaction with customers, they are not directly involved in the billing process, while those responsible for billing in the shared service centres are not proactively engaged with the customer. Consequently, we are working to establish greater cross-functional communication to ensure that billing and collection are as closely aligned with the business as possible, and vice versa. Our solution is to have individuals who are responsible for the end-to-end billing and collection process, who operate across business functions and engage the relevant stakeholders to ensure that collections are as timely and predictable as possible.
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Key to an effective working capital management strategy is visibility of cash: both what cash the company has, and what it is likely to have or require in the future. Consequently, treasurers need firstly to be able to access accurate, timely cash balances from their banks across all of their accounts. Secondly, however, the onus is on treasurers to establish a cash flow forecasting mechanism that facilitates visibility over future cash flows with as high a degree of accuracy as possible. While every company has challenges with cash flow forecasting, there is no excuse for failing to prioritise this activity. In particular, it is often difficult to obtain accurate inputs from different parts of the business.
However, by educating and incentivising business managers in subsidiaries, and implementing appropriate technology, many of the obstacles can at least be reduced. At Ericsson in Africa, for example, we have placed a strong emphasis on the accuracy of forecast information, particularly for collections. Although payables are important as part of an overall working capital strategy, these are generally easier to forecast.
In our view, achieving a high level of accuracy in cash flow forecasting is more important than over-collection. To achieve this, we have been trying to devolve responsibility for forecasting inputs to the operating units, so that billing and forecasting becomes an integral part of business management at a local level. We use a single technology platform to collect and consolidate forecast information so that processes and collation principles are consistent across the business. Once data has been collected, we refine it based on macro issues and then use this as the basis of our treasury management decisions.
For both forecasting and collections, the right motivation is essential: inevitably, people focus their attentions on areas of activity on which they are being measured. Consequently, we have established KPIs (key performance indicators) and incentives linked to forecasting and collections, which we review regularly to ensure that we are using the right metrics. Furthermore, forecasting is not a ‘one off’ activity, but an ongoing process of updating and refining. Treasurers and business unit personnel need to consider the cash flow forecast to be a living, breathing set of information that evolves as the business moves on.
Prior to the recent economic crisis most companies experienced buoyant sales so the effects of poor working capital management were masked, with cheap and easy access to credit to mitigate the effects. However, despite an improving economic situation, treasurers and finance managers should not become complacent. Firstly, the competitive landscape has changed, with growing competition from companies headquartered in emerging markets. Secondly, investors and shareholders have become more aware of the importance of efficient working capital management. Thirdly, access to credit is likely to remain constrained in the light of recently implemented regulations for banks on capital and liquidity requirements. Consequently, treasurers should be working with their colleagues across the business to establish mechanisms for optimising working capital, including guidelines for commercial terms with customers and suppliers, whatever the economic conditions. In addition, a framework for timely and accurate forecasting should be rigorously applied, supported by effective communication across the business and appropriate performance measurement. By doing so, treasurers can help to enhance the financial resilience of their firms, and increase competitive advantage.
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