Global cash visibility has been a mantra for companies for many years.
No doubt it is a worthy goal, but then business has a lot of goals. Why should this one be treated as more important than others, say one like “global profitability”?
As the last few years have shown liquidity is as important as profitability; low profitability hurts, but lack of liquidity kills. If your company has been told by its counter parties that it has no / restricted access to the external capital markets then negotiating a price or terms will not be the key issue. In other words, not having “enough” liquidity (e.g. bank borrowing) could doom a company to becoming a second class one.
Obtaining global cash visibility is the key to the issue of liquidity. Simply, it is the ability to effectively match your internal sources of liquidity (i.e. operating cash flow) to uses first, reducing the need to go into the markets. Previous studies from some of the Big 4 have shown the irony of companies that worry about how best to negotiate more sources of funds while leaving their own cash on the table. For example, watching only 80% of your cash could mean you could be 20% over borrowed. According to a recent article in CFO Magazine the effective use of liquidity will be THE issue in 2013.
Factors influencing Liquidity
Several factors constrain the effective use of internal liquidity. One is the fact that many large companies do not watch all of it. Sometimes this is because they do not know the total number of bank accounts to watch. This issue becomes especially tricky when joint ventures are involved (i.e. I thought the other guy was watching the cash?). It has become obvious to many that the use of 1980s technology (i.e. spreadsheets) compounds the problem of collecting, concentrating and reporting on “too many” bank accounts in a timely manner.
When many of these bank accounts are in non USD the task of colleciting information becomes even more difficult. Also, knowing how much cash you had last period may not be all that helpful if that period was weeks ago. Watching 80% of your cash could mean you are over borrowed by 20%. The solution to this problem involves not only the use of better technology but the more fundamental step of aligning your banking structures with your future (not past) organizational needs. After all, modern treasury technology doesn’t really care about the number of bank accounts you have as it is
capable of managing them all. Also, there is a cost of having “too many moving parts” from a bank fee, workflow and accounting and financial control perspective.
Another factor that constrains the ability of companies to manage their cash is that fact that many invest that cash in money market funds. A dirty secret of many treasury management systems is they do not play well with money market funds. Despite the advances in technology there is no common banking language (i.e. no BAI or SWIFT codes) between the demand deposit accounts at banks and the money market accounts at broker / dealers). Translating all of the transactions each day and combing balances can be done, but it requires more effort than most companies are
willing to undertake. Therefore, determining how much global cash AND cash equivalents a company has is not quite as easy as it appears.
What Does ”Enough” Liquidity Mean?
Once cash viability is obtained one must realize that it is only accurate for a moment in time when addressing the future sources / uses of funds. Since the future is inherently uncertain forecasts of the future have various degrees of volatility, usually more as one moves out over a timeline. Technology can be helpful in accumulating the data needed but it has no native intelligence or ability to understand past actions or actually predict the future. This skill is (hopefully) supplied by the uses though the use of forecasting models that have links to the real world of customers, markets, etc.
Finally, there is the issue of metrics.
- How much cash is “enough”?
- Am I over borrowed or under-invested?
- How much risk is “too much”?
Even with the global cash visibility issue solved through the use of more effective banking structures or the use of modern technology there is still the ticklish issue of matching sources of funds with the “right” uses over time to determine before it will be known if liquidity needs have been met.
Some Liquidity Solutions
A solution to this matching problem is the use of targets (by currency, by bank, by organization, etc) yet few companies have them. Many use zero to sweep all balances from all accounts every day, but this could be a naïve target ignoring the everyday needs of every organization to pay vendors, repay borrowings from other parts of the organization, payroll, etc. This zero based approach can create large transactional costs. Then there are intercompany tax issues; sweeping
all funds can create deemed dividend issues. Coupling liquidity targets such as free cash flow, days cash on hand and the length of the cash conversion cycle with profitability metrics like EBITDA and sales growth can provide give a company that additional competitive edge.
Perhaps the ultimate solution to the liquidity issue is to motivate / compensate those throughout a company to think about liquidity and risk of not having “enough” with the same fervor devoted to profitability. Treasury can do its part by negotiating with the markets to obtain the missing “delta” from the markets at the lowest after tax cost, but if the major source of cash flow can come from operations then liquidity becomes more of an operating “thing”.
By Bruce C. Lynn, CTP, The Financial Executives Consulting Group, at www.TheFECG.com