Published: August 01, 2009
In the previous article in this Guide, Erik Seifert outlined the importance of efficient, centralised liquidity management structures to ensure control over cash flow and mitigate counterparty risk. In addition, treasurers have increasingly recognised the need for both process and capital efficiency to create and preserve working capital and reduce liquidity risk. In this article, we look at some of the challenges that treasurers face in the way that they approach liquidity management, and ways of optimising this by taking a holistic approach to the financial supply chain.
Treasurers best equipped to unlock liquidity are those who seek visibility and control over the cash held in bank accounts globally, and the processes that contribute to working capital.
Liquidity is an integral element of the treasury function: this in itself is neither new nor surprising. However, as a consequence of recent events, it is now many treasurers’ top priority. According to the Cash Management Survey 2008, published by gtnews in association with SEB (‘SEB/gtnews Cash Management Survey 2008’), treasurers believe that liquidity management represents the aspect of treasury with the greatest potential for improvement (34%), a shift from the previous year in which cash flow forecasting was identified as the most important priority. Clearly the two are inextricably linked, as illustrated by Robert Pehrson in the article that follows, but there are a variety of opportunities for enhancing liquidity management. Liquidity management is also different today in that it is now viewed from a new perspective, and by people within the business who were not previously involved. For example, liquidity management is not only about fine-tuning forecasts, but also securing funds from customers and ensuring that key suppliers continue to perform. This requires that treasurers become more involved in the company’s core activities and take a more prominent role. Often, the difficulty for treasurers is firstly to identify areas for improvement, and then to take control over the processes that contribute to liquidity optimisation, and prioritise the initiatives that will deliver the greatest value. This is the essence of SEB’s Corporate Value Chain™ approach, which explores the financial supply chain as a whole, both cash and trade, to identify, prioritise, develop and deliver concrete solutions to the challenges facing corporate treasurers today.
Liquidity management is nothing new, and the solutions for enhancing liquidity, reducing liquidity risk and pushing down working capital requirements are often familiar tools in the treasurer’s toolbox. However, there are invariably challenges which conspire to thwart initiatives to optimise liquidity and reduce the company’s working capital requirement.
Centralisation of cash has been a priority for many treasurers for a number of years, often with significant success. However, there is frequently further progress that can be made. Centralisation takes a variety of forms, and treasurers best equipped to unlock liquidity are those who seek visibility and control over the cash held in bank accounts globally, and the processes that contribute to working capital.
Looking first at cash management structures, while many companies have adopted cash pooling or concentration solutions that centralise a portion of cash flow, there are often some countries or regions that remain outside of these structures. In addition, treasury and cash management may be centralised in some parts of the world, but other countries and regions retain local cash management autonomy, making it more difficult to achieve global visibility and control. According to the SEB/gtnews Cash Management Survey 2008 (figure 1) a surprising 28% of companies currently have a decentralised cash management structure, although the majority plan to centralise cash management in the future, ideally on a global scale. [[[PAGE]]]
While implementing cash management structures, such as notional or physical cash pooling, and maintaining bank relationships are clearly priorities to increase visibility, control and mobility of cash, optimised liquidity also requires efficient internal processes. Figure 2 gives a simplified example of the financial processes which ultimately contribute to the cash position. According to the SEB/gtnews Cash Management Survey 2008, the majority of respondents believed that processes which contribute to working capital (such as purchase-to-pay, order-to-cash and inventory cycle) to be average or good, with few considering them to be ‘best practice’.
One of the challenges of optimising internal processes, however, is that few treasurers hold responsibility for working capital, and the processes that contribute to it. Although the trend over recent years has been to extend the range of activities for which treasurers are responsible, only 24%1 of treasurers (a lower percentage than anticipated by respondents in the same survey conducted in 2006) have a leading role in working capital management, with 11% having no involvement at all. This creates a serious dilemma for treasurers: on the one hand, they are responsible for ensuring sufficient levels of liquidity for the business, which requires a focus on working capital; on the other, they are not often in a position to direct the activities that contribute to it. SEB takes a holistic view of liquidity management, and seeks to help companies not only with the activities for which treasurers are traditionally responsible, such as FX, debt and investment, but also the processes that make up the wider financial supply chain.
An area in which treasurers need to take greater control is trade finance, specifically trade-related flows, in order to better manage working capital.
A typical example of an area in which treasurers need to take greater control is trade finance, specifically trade-related flows, in order to better manage working capital. In addition to the SEB/gtnews Cash Management Survey 2008, gtnews published a second survey in association with SEB exploring trade finance issues (‘SEB/gtnews Trade Finance Survey 2009’). According to this survey, only 14% of treasurers have a leading role in trade finance, with a further 65% either partially involved or occasionally consulted. Although companies have made substantial progress in improving the efficiency and visibility of cash flows, many firms have yet to make the same progress in trade flows. For example, according to the same survey, delays and errors are common in many trade finance processes that would not be tolerated for other types of cash transaction flows. 28% of companies do not measure the errors in their trade documentation, and 41% of respondents also admitted that they are not able to map their trade finance processes, such as monitoring document types, tracking trade finance activities, recording turnaround times, unit cost and risk assessment. The effect of inadequate governance in the trade process can be a substantial loss of visibility and predictability of trade flows. For example, according to SEB’s analysis of companies’ letter of credit portfolio, the average lead time from shipment to payment is 41 days, against best practice of 10 days, creating a working capital lag of 31 days. Despite the importance of working capital management for many companies, 41% of companies do not use trade finance at all to extend their DPO or reduce their DSO. In some cases, companies are not aware of how to use letters of credit to improve working capital efficiency, both for import and export purposes, therefore eliminating a potential liquidity tool.
There is clearly an opportunity for improving the efficiency and visibility of trade flows, but a greater opportunity still is to consider trade flows and cash management flows together: by isolating trade finance and cash management into separate departments or areas of responsibility, the total value that could be gained by taking a holistic view is reduced. [[[PAGE]]]
With significant potential in many companies for refining financial structures and processes to optimise liquidity, the next challenge is to identify and implement potential solutions.
Of those that have centralised their cash, zero/target balance pooling is the most common technique used (52%) followed by intercompany netting (32%) and notional pooling (19%) (source: SEB/gtnews Cash Management Survey 2008). Inevitably, there are advantages and disadvantages to each technique, particularly due to regional variations in legal and tax rules. The survey reveals growing interest not only in regional cash centralisation, but also global cash management strategies. At a regional level, with SEPA (Single Euro Payments Area) now in effect, and the PSD (Payment Services Directive) coming into force in November 2009, we see greater harmonisation of cash concentration opportunities, leading to treasurers being able to take a more consistent approach to pan-European cash centralisation. As yet, SEPA has really been a ‘non-event’ for most corporates, and most SEPA flows we see today are cross-border payments as opposed to replacing domestic EUR payments. There are exceptions of course, and companies that have taken early advantage of new initiatives such as SEPA payments, and the ISO 20022 formats on which they are based, have derived significant benefit. For example, one of our clients has implemented ISO 20022 message formats not only for SEPA payments but also for cross-border payments outside Europe and even for Euro transactions via the Swedish Bankgiro. There are two key opportunities that SEPA presents to corporate treasurers:
Firstly, most companies today have local cash pools within each EU country, with balances then swept into a central cash pool. The opportunity now exists to route flows directly through a single, pan-European cash pool, eliminating the need for local pools and cross-border sweeping. While the full benefit will be achieved when SEPA extends to domestic as well as cross-border payments, costs will be reduced substantially and treasury will have far better intraday liquidity management with more immediate access to funds .
Companies that have taken early advantage of new initiatives such as SEPA payments, and the ISO 20022 formats on which they are based, have derived significant benefit.
Secondly, and a highly compelling proposition for many firms, is the greater ability that SEPA presents to centralise financial processes through shared service centres (SSCs) across the Eurozone based on consistent processes and message types. Today, establishing pan-European SSCs and common processes can be difficult due to the need to support local payment and collection types with a variety of formats and local requirements.
The opportunities for managing global liquidity are also increasing. In some cases, this could mean cross-border and cross-regional cash pooling, but there can be challenges when dealing with multiple currencies, particularly non-convertible currencies, and regulatory restrictions in some countries. Achieving a global view of cash, however, does not always require complex cash concentration solutions. A treasurer ultimately needs global visibility, including accurate forecasting, timely access and the ability to mobilise cash globally. Bank connectivity solutions, such as SWIFT Corporate Access, working with banking partners with the right international network and building a relationship with a bank that understands your cash management needs fully can be crucial steps towards achieving a global cash and liquidity strategy.
For many companies with a heavy reliance on imports or exports, trade finance is a crucial element of the financial supply chain, offering significant opportunity for improvement in risk management, process efficiency and working capital. According to the results of the SEB/gtnews Trade Finance Survey 2009, only 27% of companies had any integration between trade and cash. Improving trade finance processes represents a huge opportunity for enhancing liquidity as well as creating assets for financing purposes. A payment impacts on the company’s cash position equally, whether or not generated through open account or using trade instruments, and treasurers need the same visibility, predictability and efficiency of cash flow in order to manage liquidity effectively. Trade can also be a huge drain on liquidity and potentially increase a company’s debt burden considerably. For example, if the trade governance model is not clear, it is not uncommon for an importer to be financing a supplier for up to 180 days at a direct cost to the importing company. Increasingly, this issue is becoming more apparent and less tolerable in a difficult borrowing environment. By becoming an agent of change in cash management, trade flows, and potentially also in procurement, the treasurer’s role becomes far more active in the business as a whole, and essentially becomes that of a sales support function. [[[PAGE]]]
A holistic approach to liquidity management creates value by enhancing process efficiency and leveraging cash management structures, but there are also further opportunities. Every step of the financial supply chain represents an asset which could be used as another means of creating liquidity. For example, invoices, trade receivables or even purchase orders can be used as collateral for financing or cash flow enhancement. In an environment where companies of all sizes may have found it more difficult to source credit through traditional mechanisms, alternative financing arrangements can be a valuable tool.
Supply chain financing is an excellent way for companies with a stronger credit rating to support their suppliers, with advantages to both sides.
Another way in which treasurers can play a substantial contribution to the core activities of the business is supply chain financing, which is an excellent way for companies with a stronger credit rating to support their suppliers, with advantages for both sides. Buyers benefit from longer payment terms and therefore greater cash flexibility; suppliers gain earlier, predictable payment and effectively a credit line from their buyer’s bank. One SEB client, for example, a large buyer based in Sweden, has increased its average payment period from 44 days to 77 days, without compromising suppliers’ cash flow, and indeed building stronger relationships with them. For a company with a turnover of approximately SEK 40bn, this represents an important contribution to working capital management.
However, while we are seeing increasing interest in supplier financing and sales support financing, which could take the form of external payment terms or vendor financing arrangements, there are many more companies that could take advantage of this type of opportunity. There are various reasons why treasurers and finance managers have chosen not to do so until now. Firstly, there is a lack of awareness of financing opportunities in some cases. Secondly, companies inevitably have limited resources. Setting up a financing programme takes time and resourcing, and treasurers have to prioritise their activities. Thirdly, companies often overestimate their ability to extend payment terms with suppliers, so they do not consider that alternative financing has value for them. Some industries are more concerned about increasing resilience in the supply chain than others, and those that can potentially source from multiple suppliers, and change supply arrangements quickly, are less motivated by supplier financing. However, for many companies that are seeking new sources of financing, and for whom working capital is an important consideration, there are significant opportunities.
As we have established, treasurers have a wealth of opportunities available to them for enhancing liquidity, but they have limited resources available to them to deliver these improvements. Furthermore, with the liquidity agenda influenced by different departments or subsidiaries, it can be difficult to gain internal consensus on what areas to prioritise, and co-ordinate resources from different parts of the business. SEB’s Corporate Value Chain™ approach helps treasurers and CFOs gain a pragmatic, objective view of their treasury and finance activities, across the financial supply chain, and identify projects that can deliver the greatest value. This is a systematic way of assessing the business, and identifying, prioritising and addressing opportunities for enhancing processes to help deliver on a company’s financial strategy. Since launching the Corporate Value Chain, we have seen significant interest from clients and implemented projects that have achieved substantial tangible benefits. With liquidity optimisation likely to remain a priority for treasurers of companies of all sizes for the foreseeable future, adopting a methodical, consistent and measurable approach to effective liquidity management is a vital way that treasurers can add value to the business.
1 SEB/gtnews Cash Management Survey 2008
With thanks to Johan Waldemarsson for his contribution to this article
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