At the peak of the credit crunch, international companies like Temasek in Singapore, Marks & Spencer, John Lewis Partnership and Taylor Wimpey, which were thought to be resilient, sent out signals that they were feeling the squeeze. Having witnessed such vulnerabilities, every business should take cues and be mindful of its funding requirements in the current environment.
The current problem is not just a lack of liquidity in the money markets. Despite current reports of economic recovery gaining momentum (albeit slowly), companies are starting to look at cash flow with a newly critical eye, hoping to avoid the nightmare of falling revenues unmatched by lower cuts.
Cash monitoring and forecasting may not be the most strategic or interesting parts of the CFO’s role – in fact, they’re delegated functions. But given the lack of liquidity and looming economic difficulties right now, CFOs are expected to be aware of their cash position at any point in time.
Whereas net-income forecasting was sufficient in the past, many investors are now requiring companies to produce a rolling twelve-month cash flow forecast. That means having the right tools in place to be able to track data throughout the ‘financial supply chain’ in your own organisation, and having consistent management information.
According to the late George Moore, founder member of the Society of Turnaround Professionals, having an accurate cash forecast can spell life or death for a business during a downturn. ‘A realistic and well-researched cash flow forecast 13 weeks out will pick up sudden increases in sales and costs,’ he told Real Finance magazine in 2006. ‘It’s pretty straightforward to work in the payments side – the salaries, taxes, leases and supplier invoices. All you have to do then is estimate the collections you’re sure about and you’ll see straight away what you’ve got to do in terms of sales and improved collections.’
Outgoing figures are also vital: activity-based costing, for example, can highlight overhead costs that can be eliminated and unprofitable lines that should be the first on the chopping block.
One aspect of working capital often obscured from management is disputed invoices. Struggling clients will be managing their own working capital, and that can mean late payments or haggling; more complex disputes can put large sums into the dreaded ‘120+ days’ column. Rather than festering in the bottom drawer of an account executive, disputes that are quickly raised to management’s attention, then to the director level, will be better solved. Fast decisions can be made about potential refunds, negotiations with client decision-makers can begin, or legal action can be taken.
Companies are increasingly adopting integrated systems to automate cash-related processes. Large companies can take this one stage further with centralised shared services and outsourcing. Again, the credit crunch and economic downturn are very persuasive arguments for a general tune-up in finance function efficiency – and creating visibility in cash flow should be a prime driver.
Cash management comprises more than just great systems and transparency in the finance function. From the moment a purchase order is taken, to the payment of the final invoice, there are plenty of opportunities to influence the working-capital cycle. Proactive cash management starts with the right credit decisions. As the sub-prime mortgage crisis illustrates, inappropriate underwriting rules can seriously damage business viability. Therefore, a credit policy should be clearly defined, and should include your company’s credit criteria, standard payment terms and detailed reporting requirements – and be signed off by the board.
It is vital to ensure that invoices are accurate and timely, and that payment standards are clearly stated. Providing user-friendly payment facilities – such as online payments or direct-debit options – will also help. Offering a discount for prompt or early payment is a great way of improving cash flow. And, if you need to tighten the belt another notch, you always have the option of re-setting the credit terms offered to customers.
Your collection processes, routines and controls are critical to cash performance. Again, many companies have the best intentions, but metrics such as DSO (days sales outstanding), which are essential in monitoring working capital, can end up being overlooked.
With an uncertain economic outlook, it makes sense to conduct a daily review of the receivables report. It’s a great way to spot gradual tightening in specific sectors or emerging problems with key clients.
It’s also important to make stars out of the credit-control team. They usually toil away in obscurity, but they are the engineers in the boiler-room of working capital. If they’re not already so, turn them into ‘account managers’. Provide them with a remit to help you understand your customers better, and to create relationships that could make the difference between getting paid on time or a few days late. Staff incentives can also have a significant impact – and not just in the risk or credit-control teams. Sales people should understand that a sale is not complete until the payment has been received. Remuneration should be linked to the appropriate collection metrics.
Finally, if your company’s standard terms and conditions include penalty interest on late payments, now could be the time to enforce them. That sort of policy tightening requires a certain degree of diplomacy. But if it is part of a broader approach to contract enforcement that includes advantages, such as early-settlement discounts, it can be done.
Supplier management can also play a critical role in the finance supply chain. However, it’s worth bearing in mind that cash management in the payables function need not mean late payments or chiselling hard-up suppliers for more favourable terms.
Managing your payments against supplier terms should be the first approach, but this is another area where companies often fail to look at the details for each and every case. So make sure suppliers are paid on the exact due date – except where it makes sense to take advantage of pre-agreed discounts for early payments. Accurate cash forecasting will help you decide whether less cash flowing out now is better than slightly more later on.
When selecting a new supplier, the procurement team should take into account any flexibility around payment terms. That means a management accountant will need to brief buyers and line managers on where they ought to be negotiating, rather than simply looking at the lowest prices.
It’s also a good time to strengthen purchasing policies. At the macro level, CFOs should consider whether there are opportunities to consolidate suppliers. Of course, approval processes for expenditures should be strictly adhered to. You should also consider lowering the value threshold for CFO sign-off – or automating the approval process to ensure senior managers are held accountable.
Good inventory management can also improve working-capital performance. As with other aspects of cash management, transparency is the key. The finance team should use the cash forecast to crunch numbers in a way that plots a path between minimal stock, a satisfactory supply chain and maximum benefit from procurement terms. And does the offshore manufacturing deal still look as good when you factor in the six weeks your stock will be sitting on a boat?
Minimising working capital, having efficient processes and developing a clear, accurate forecast of cash are all must-haves, especially during a downturn. But whether you need to boost working capital to cover a sales slow-down or, more importantly, invest for growth ahead of an upturn, additional borrowing could still be on the agenda.
Assuming the bank will be less keen to lend now than it might have been 18 months ago, or will be imposing tougher covenants or higher lending rates, you’ll need to look at alternative sources of cash.
While cash pooling – netting off your cash positions across different parts of the business to minimise its overall debt position or maximise interest received – is already a mature product, not all corporations have adopted it. But it can be a powerful tool for efficient cash management and allows businesses to strengthen controls, maximise cash return, decrease borrowing needs and get easier access to funds.
Cash pooling is a no-brainer, whatever the economic climate. But there are other options that become attractive only during these more uncertain credit and trading conditions.
Factoring and invoice discounting, for example, will help to accelerate cash cycle, although the receivables will have to be sold at a discount – and the fees can mount up. It’s certainly a growing market: the invoice finance sector grew by 460% between 1995 and 2005. By 2006, over £19 billion of receivables were in play with finance firms in the UK alone.
Terms will differ between factoring companies, and in recent years, ‘confidential invoice discounting’ (which hides the arrangement from your customers) has risen in popularity. So it’s worth shopping around. Don’t forget to check whether your bank will accept a loan using account receivables as collateral – their fees will typically be cheaper.
Selling non-core assets is another option for larger cash injection. For example, Lloyds TSB raised funds through its sale of its Abbey Life business to Deutsche Bank in July 2007. Property sales should also be considered. Also in 2007, HSBC arranged a sale-and-leaseback deal on its global headquarters, which in turn managed to raised £1.1 billion in cash.
Then, there are the really tricky areas. In today’s market, delaying investments is probably already on the CFO’s agenda. Capital expenditure aimed for growth might not be a priority right now, with senior management preferring to focus on cash management. But hasty cuts, in areas such as marketing, could have a detrimental effect on medium-term cash flow. Again, the management team needs to be able to see how things will play out in the twelve-month rolling cash forecast before making decisions that could kill the company, just as an economic upturn rolls in.
Overall, cash management requires companies to have the right tools available, ensure the basics are in place and think creatively when it comes to alternative sources of funding. It’s an opportunity to reassess systems and processes through the organisation – in different departments and at every level – to ensure that best practices in cash management are in place.
The late George Moore offered some sage advice. As the founder of the Society of Turnaround Professionals, he is something of a guru for those interested in helping companies out of a fix. Depending on the depth of the downturn and the extent to which your business is starved of cash, these tips might find a place in your bottom drawer:
- Negotiate with suppliers. Will they accept cash up front for new orders and an orderly but gradual pay-down of accumulated debt?
- Analyse your optimum return on capital. If the cost of borrowing is high, for example, see if you can settle debts early. Instead of paying interest, use the cash flow to secure early payment discounts from suppliers
- Beware of invoice discounting. It’s relatively expensive, but you can run into problems if your product sales encounters a dip. To utilise this, you’ll need to understand your business cycle well. Borrowing against physical assets is smarter.
- Consolidate debt into a long-term bank loan and arrange a suitable overdraft for day-to-day fluctuations. Shareholders will see more value when you gradually chip away at the bulk of the debt.
- Look for disaggregation opportunities. Often, businesses own assets that would be more valuable under a different structure. For example, a solution may be selling property to a company commonly owned by the shareholders, then leasing it back. That loop will fence the value for owners.
- Sweat your assets. A manufacturing facility that runs eight shifts a week can be spun off as a new business and find customers for the other shifts.
About the Author
Aubrey Joachim is a management coach, mentor and management-training provider. He leads conference and seminar companies, and provides training programs across Australasia to professional bodies. He has served as branch secretary and, later, president of CIMA’s New South Wales Branch (June 2009 to 2010).