by Thomas Schräder, Partner, and Thomas Hampel, Senior Manager, PwC - Corporate Treasury Solutions
Attempting to forecast their future liquidity, global corporations are increasingly challenged. Highly volatile markets, macroeconomic ambiguity and political risk in target markets are factors that boost uncertainty. In such an environment, expected revenues are likely to fail to materialise and banks as well as capital markets provide external funding only reluctantly and at high costs. Because of this, it is more vital than ever for corporations to identify internal financing capabilities and to have a clear view on their future liquidity development. Both are necessary to survive volatile economic cycles and to ensure sufficient funding to keep operations running.
One major prerequisite for coping with these requirements is the establishment of a robust, comprehensive and reliable liquidity forecasting and reporting process. The immediate availability of validated information and transparency as to its origins are critical success factors. At the same time, flexibility in assessing, consolidating and presenting the information needs to be granted.
However, the growing complexity of business processes imposes two major challenges:
1. Implementing consistent and comprehensive horizontal data integration covering all relevant systems and business units involved in the process
2. Implementing vertical data integration which combines operations’ transactional data and further decision-relevant information
The traditional forecasting approaches (i.e., direct and indirect cash flow forecasting) applied by corporates are not always capable of fulfilling those requirements.
Indirect cash flow forecasting is based on forecast balance sheets and income statements. As they are usually the result of the yearly budgeting process, the time horizon is often limited to the financial year end. Moreover, the budgeting itself is usually focused on goals such as resource allocation and target setting. Cash flows are often calculated on the basis of historical figures, scaled to a certain extent to adapt to future expectations. Since indirect cash flow forecasts are also often closely aligned to the overall target as defined by the companies’ top management, they may be less useful for the operational management of liquidity. Their potentially political nature and the fact that they are not purely based on forward looking facts may harm the general applicability for decision-making within treasury organisations.
On the other hand there are - within treasury organisations - widely used direct cash flow forecasting methods. They emphasise the direct determination of cash flows and are purely value date focused. Depending on the industry and business model of a company, a large amount of forecasting data for the short- to mid-term horizon may be directly obtained from corporates’ ERP or treasury systems. For instance, receivable or payable transactions already accounted for in the ERP usually provide sufficient information to consider them directly in the cash forecast. As long as there is at least information on the over-all amount and the future maturity date, one can use that directly for forecasting purposes.
However, future-ranging cash data from an ERPs receivable / payable ledger, forward order book or modules related to financial or investing transactions is not usually available long-term. Instead cash flows for the long-term horizon are often estimated simply based on the scaling of historical data or rough approximations of certain individuals. Next to those content deficiencies there are often challenges associated to the underlying forecasting process and a lack of appropriate IT support. Many forecasting processes are supported solely by the use of spreadsheet programmes such as Microsoft Excel. The strong reliance on Excel often makes the whole process very time-consuming, inefficient and error prone. Usually people spend more time managing the complex spreadsheets than actually analysing the data. As a result, internal and external reporting requirements are only insufficiently adhered to. Confidence in the resulting planned liquidity can be low, which makes it less useful for management decisions.
A new approach
To address the issues inherent in traditional forecasting approaches, PwC Corporate Treasury Solutions together with a leading German automotive manufacturer has developed a new approach called Value Chain Liquidity Forecasting. This establishes maximum transparency on the origin of forecasted cash flows and takes planning accuracy to a new level. Considering relevant information from every major department and division of the company, the approach explores all cash generating mechanisms within the value chain. In doing so, all parameters determining both extent and occurrence of cash flows are uncovered. In the end full transparency on future cash flows and their origins is established, which is of significant benefit particularly when considering the ever increasing complexity of business processes and operations.
More specifically, the value chain-driven approach enhances the direct cash flow forecasting method. It can significantly increase data quality, forecasting accuracy and transparency over the full forecasting horizon by automatically integrating data from a large variety of pre-systems, and it is not restricted just to finance or accounting systems like ERPs. Pre-systems which allow for an analytical construction of cash flows are often operational systems; for instance systems which control production processes, storage and logistics, sales and distribution, materials management, investment projects or R&D expenses. Obviously, information from all of these systems have to be processed in order to provide the desired cash flow information. To make this happen, the complete value chain of the given company gets simulated, using specific calculation logic based on the particular data input.[[[PAGE]]]
Figure 1 illustrates the determination of cash flows stemming from car sales activities. The basis for forecasted cash inflows from sales activities is a detailed plan of car sales numbers. It is supplemented with planned unit sales prices and average turnover times. With these input factors, the future stock of finished goods is predicted for every point in time, as well as the invoicing date for every unit sold. Information on expected payment behavior per customer leads to future receivables, which finally result in forecasted daily cash inflows.

The same approach is applied to provide cash outflows. In this case the calculation is based on the production plan, corresponding unit production costs and the company’s own payment behaviour towards suppliers.
Forecast stocks of inventory, receivables and payables are side products of the calculation of cash flows, but they also allow the analysis of planned working capital in great detail. The source and calculation of the steps leading to every cash flow are automatically traced, which facilitates detailed deviation analyses and helps to discover causes for planning errors. A further benefit is the reconciliation of the liquidity forecast with the yearly budget. This makes it possible to challenge and cross-check the validity of underlying strategic assumptions of the latter.
Value chain scenarios
Scenarios for all factors and parts of the value chain can be created and applied. For instance a reduction in payment terms for a group of customers would lead to cash flows from sales being materialised faster. In turn the receivable balance will decrease, as does working capital. It is also possible to simulate a corresponding customer demand reaction. The sales plan can be adjusted down to a lower level and prices can include cash discounts. Going forward, possible actions to strengthen internal financing can be tested and confirmed in advance. Moreover, since cash flows are planned in foreign currencies, it is also possible to define and apply FX scenarios to challenge the effectiveness of the chosen hedging strategy.
Probably one of the most interesting analysis functions is the Forecast@Risk, where we expose data from the cash forecast to sophisticated statistics based risk simulations. @Risk analyses can be carried out for operational risks as well as for financial risk, while results are integrated into an easy-to-read (user group aligned) report set which indicates the impact of risk on cash flows and projected net liquidity within bandwidths (see Figure 2).

Due to the comprehensiveness of the data model, reports are available on different aggregation levels and all figures (including @Risk) can be drilled down to the transactions bearing the risks.
Obviously, the extent and complexity of features within the Value Chain Forecasting And Treasury Reporting Solution pose a challenge to the technical platform that supports processes and functions. Standard treasury systems which focus mainly on supporting daily tasks in transaction management, cash management or payment processing do not usually have adequate forecasting and reporting capabilities. Therefore, the solution is designed to be implemented on the basis of market-leading business intelligence (BI) technologies like those of SAP, Microsoft, IBM and other platform providers.
Seamless integration
Using automated interfaces to relevant pre-systems like ERP or production systems, the solution is seamlessly integrated into the wider IT landscape. It features several standard web reports, as well as in-depth ad-hoc reporting capabilities using Excel and other self-service BI components. Reports are created in line with information design best-practices and are embedded into a simple-to-use single page application, providing access to all functionalities of the solution. Top management may also access dashboards and key performance indicators (KPIs) through specifically designed mobile interfaces for tablet and smartphones.[[[PAGE]]]
Further leveraging BI capabilities, we also improved the overall structure and content of the existing treasury reporting next to streamlining the report creation process. Sophisticated financial risk reports with data from treasury management systems, ERP, financial data providers and the cash forecast are now created instantly in a one-click solution.
Treasury users also benefit from other process-supporting functions enabled by technology and leveraged in the solution. Integrated collaboration and document management features allow for central storage of reports and important documents like treasury guidelines, process manuals and other working documents. All content is indexed and fully searchable, making network drives and local file storage obsolete. An integrated user rights management prevents unauthorised access. The workflow functionality supports cash forecasting and treasury reporting processes with reminder functionality and approval functionality. The status and progress of the tasks can be tracked globally at user or subsidiary level. All the features are accessed over a web-interface via a desktop, tablet or phone. The solution truly is the single point of entry for all daily activities within treasury and has become an integral part of the overall treasury set-up of the client.
Conclusion
Altogether, a considerable improvement in transparency and reliability of the liquidity forecasting as well as the financial reporting processes can be established. As all data is readily available in real time, new reporting requirements are now fulfilled in a timely and use- oriented manner. The solution finally provides the basis for qualified management decisions. A further supporting factor is the involvement of all company divisions, which also leads to a better understanding of treasury operations within the company and stronger orientation to their needs and tasks within the divisions and subsidiaries.
