Published: November 01, 2010
In mid-2009, Maciej Müldner, Treasurer of Skanska Poland outlined how treasury approached risk management in the light of the crisis. Just over a year on, this article summarises Skanska’s strategy, its effectiveness and how the business has developed.
Skanska globally combines both centralised and decentralised elements in its financial management strategy. Skanska Financial Services provides a central in-house bank, but there is also a treasury function for each business unit. In some cases, such as in Poland, this comprises a team of 12 individuals, while in other countries, the treasury function may be smaller. Treasury in Poland needs to support between 100-300 projects each season, each one of which operates as a separate entity. Around seven members of the team provide daily financial operational support to these projects and the remainder are involved in cash management.
We conduct transactions across a range of financial instruments, including traditional hedging, capital financing, leasing, project finance etc. and perform all associated activities with the exception of accounting. To enable this, we use several modules of a TMS (treasury management system) globally which is integrated with our general ledger. This is used across the business, supporting all our main business lines including hedging, cash management (which also comprises a payments factory), documentary credits (such as guarantees), which are important in the construction sector, and insurance lines.
Skanska Financial Services provides a central in-house bank, but there is also a treasury function for each business unit.
This organisation has proved very effective throughout the crisis. We are well-equipped with the skills and technology we have in place, and as we look forward, we are positioning ourselves to manage business expansion. For example, we are considering ramping up our staffing, such as recruiting graduates to whom we can provide an attractive career path, as well as ensuring that we have the right skills and experience in place as the company grows over time.
For many years, we have adopted a consistent set of risk management processes globally, termed ‘Operational Risk Assessment’ which is central to the way we work. For each business opportunity, we perform a detailed risk assessment, which includes technical issues, such as human resources, health and safety and environmental impact, but also financial risks. This comprises a detailed, step-by-step process to assess requirements in terms of hedging, cash flow, guarantees, insurance and counterparty risk. The Operational Risk Assessment approach has now been in place for more than eight years, so it is deeply entrenched in our working practices and project teams have the necessary expertise to conduct the necessary risk analysis. Having assessed a project’s financial risks, treasury then helps the project team to find ways of mitigating them. Ultimately, the project manager is accountable for all aspects of the project, including finance, and treasury provides a vital support function.
Since September 2008, there has been an even greater focus on risk management across the Skanska group. We have revisited high-risk projects to assess whether they are subject to any additional risks beyond those we had originally determined. In fact, the outcome of this process was positive as the Operational Risk Assessment model was found to be robust.[[[PAGE]]]
We aim to adopt a balanced approach, understanding the nature of the risk and putting in place an appropriate financial structure.
Following a review of our risk management approach, the only area in which we decided to expand our focus was counterparty risk, not in relation to the client, but the risk to suppliers and subcontractors, many of which are smaller companies that we recognised could be hit hardest by the crisis. We have over 6,000 suppliers in Poland alone, so it would be unrealistic to conduct a detailed review of each one’s financial position; however, we look at the primary risks for each project, which could be highly specialist firms. Indeed, we have seen some bankruptcies, but by maintaining a close relationship with suppliers and assessing their finances, including bank opinion, on a regular basis, we have recognised ‘early warnings’ of financial difficulties and have been able to take the necessary steps. Initially, suppliers did not understand why we asked for financial information and the importance of data validation for us, but in fact, this approach enabled us to help companies sooner. In particular, some suppliers have found that other customers have not paid them on time, leading to working capital difficulties. While it would be prohibitively expensive to provide bank guarantees, we want to support these suppliers and contractors as effectively as possible.
We aim to adopt a balanced approach, understanding the nature of the risk and putting in place an appropriate financial structure. Often people think that a standard financial product can simply be applied to a business transaction; in contrast, we need to understand the risk and construct a specific risk mitigation strategy. In some cases, this could involve third-party insurance, although this takes time to organise. For some suppliers, we use supplier financing, such as working capital finance through a commercial bank. This works well for some suppliers, particularly small and medium-sized enterprises (SMEs) who want to accelerate their collections, but it is not suitable in every situation. While we had used supplier financing in the past, we became more active as we saw SMEs increasingly vulnerable to the crisis.
Our hedging strategy has also changed somewhat since the crisis due to the increased volatility and lack of liquidity in the market. We have found it difficult to implement some of the techniques we were using to manage longer-term risks. For example, we used to hedge all project cash flows at the start using long-term swaps, whereas now we have to put in place transactions with a shorter maturity and roll them over as necessary. From a currency risk perspective, we remain conservative and hedge 100% of our currency risk immediately, the cost of which is embedded into the overall project cost.
While the financial crisis has largely passed over, the economic crisis in many parts of the world still persists, particularly in industries such as construction, and we anticipate that volatility and vulnerability will continue for at least another 12 months. We will continue to see bankruptcies, but also more companies taking advantage of the changing economic climate, with an increase in M&A activity. Treasury needs to keep close to the business and keep a close awareness of what is happening, as opposed to relying on press headlines. For Skanska, a major achievement in recent times has been the strengthening of the relationship between treasury and the business as a whole. Each business function now understands what treasury does, the financial needs of the company and how each department can help to mitigate risk and further our financial objectives. This was particularly important during a period of crisis. With fast-changing conditions, we had to plan but also react quickly, as what is possible at one point in time may not be so easy in the future. We did a great deal of training on hedging foreign exchange flows, so that everyone in the organisation recognised the importance of identifying and managing this risk.[[[PAGE]]]
Based on a greater awareness of risk across the business, we have also been able to strengthen our approach to credit risk management. Dealing with credit risk as a debt collection function is too late, so we will be introducing new customer relationship management (CRM) systems over the next few months. While this is still uncommon in the construction industry, we recognise that by understanding customer behaviour better, and dealing with outstanding invoices systematically, we can reduce bad debts significantly and prevent small amounts of delinquency from becoming more substantial.
While Skanska as a business is cash-rich, it is important for us to recognise that the company is going through a development cycle as the construction industry picks up, with signals such as the renewed demand for residential and commercial property in the United States. Leveraging new business opportunities can absorb a great deal of cash, so cash flow forecasting has become a higher priority, even though this is a never-ending task. Our forecasting abilities are the reverse of many companies: while we can forecast medium- and long-term cash flow (i.e. 3 to 12 months) with a reasonable degree of accuracy, based on contracted projects, predicting short-term flows is more difficult. For example, while we can control outflows to our 6,000 suppliers and subcontractors, it is far more difficult to control the payment timing by our customers. Even one day’s difference from the forecast date can significantly affect the usefulness of our forecast.To address this, we have adopted a two-pronged approach. Firstly, we remain close to the business
Based on a greater awareness of risk across the business, we have also been able to strengthen our approach to credit risk management. Dealing with credit risk as a debt collection function is too late, so we will be introducing new customer relationship management (CRM) systems over the next few months. While this is still uncommon in the construction industry, we recognise that by understanding customer behaviour better, and dealing with outstanding invoices systematically, we can reduce bad debts significantly and prevent small amounts of delinquency from becoming more substantial.
While Skanska as a business is cash-rich, it is important for us to recognise that the company is going through a development cycle as the construction industry picks up, with signals such as the renewed demand for residential and commercial property in the United States. Leveraging new business opportunities can absorb a great deal of cash, so cash flow forecasting has become a higher priority, even though this is a never-ending task. Our forecasting abilities are the reverse of many companies: while we can forecast medium- and long-term cash flow (i.e. 3 to 12 months) with a reasonable degree of accuracy, based on contracted projects, predicting short-term flows is more difficult. For example, while we can control outflows to our 6,000 suppliers and subcontractors, it is far more difficult to control the payment timing by our customers. Even one day’s difference from the forecast date can significantly affect the usefulness of our forecast.
To address this, we have adopted a two-pronged approach. Firstly, we remain close to the business, working with the sales teams who communicate directly with customers, in order to understand customer behaviour and constraints as best we can. However, this is difficult bearing in mind the large number of projects under way at any one time, and the existing workload that our sales team already manage. A second approach was therefore to build a system in-house to help manage risk more effectively and automate business processes.
As a result of the disciplined approach that Skanska has taken to managing risk throughout the crisis, including close interaction between treasury and the business, and the ability to anticipate and respond to issues early, the company has navigated successfully through stormy times. Although revenues fell during a very difficult period for the construction industry, Skanska’s profitability increased from 2008-9 and return on equity rose by 3%. Looking ahead, as the company enters a period of growth, the same degree of discipline, risk management and mutual commitment to achieving objectives across thebusiness will place it in an excellent position for the future.
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