Home / 2009 / February 2009 / Weathering the Storm

Although important at any time, effective cash management is vital when the economic horizon darkens, says Alan Morris.

Cash is the lifeblood of every business. A business can generate profit, but without cash it is unlikely to survive. In good times, companies seek growth and profits and are rewarded for doing so, even if those increased profits consume cash. But, investors get their return by being paid cash, and it is cash that pays the bills, not profit. In today’s climate of continuing uncertainty in global consumer and capital markets, weakening consumer demand and significantly reduced liquidity, management of cash has taken on a new and much greater importance for all business managers.

Effective cash management is one of the most direct ways to reduce wastage and inefficiencies in the business, optimising funds available for investment and reducing interest costs. Improving cash flow can have immediate results in terms of improved credit ratings and higher share prices. And with lenders now concentrating on the ability of businesses to generate positive cash flow, it is important for business managers to understand and manage the cash cycles within their business effectively. By doing so, the need for external finance can be minimised, and the likelihood of sourcing additional finance where required can be maximised.

With cash flow pressures being felt across Irish business, now is the time to focus on cash management. So, how can managers drive improved cash management within the business? And how can they ensure that improvements made are sustainable?

THE KEY TO SUSTAINABLE CASH FLOW IMPROVEMENT A common characteristic of high-performing companies is their constant focus on cash and working capital, delivered through processes and behaviours that have been embedded in the business. The best-performing businesses start with a strong focus on forward visibility and control of cash flows based on a detailed understanding of the different cash cycles in the business. They have clearly defined targets which cascade across functions into individual and business goals and incentives. Roles and responsibilities are clear to all, especially around the ownership of working capital.

More important than anything, cash and working capital management is made part of business as usual, not a one-off exercise. Executive sponsorship and effective communication is vital to driving the message on cash and working capital management across the many parts of a typical business.

For most businesses looking to improve cash flow, the focus is given to better management of working capital. While this is without doubt a key area that businesses should put under the microscope, effort is often targeted on delivering quick, rather than sustainable, wins. It may be an easy enough task to release significant cash trapped in excess stockholdings, but unless the reasons for the stock build up are understood the gains will be temporary. Similarly, the squeezing of customer credit terms or stretching of days’ payable outstanding may help in the short term, but are unlikely to deliver lasting cash flow improvement unless undertaken as part of a wider cash management programme.

Given the recent credit crunch and the ensuing economic uncertainty, it is understandable that finance organizations merely do what they need to do to get through the next week, month or quarter. But such actions won’t serve the longer-term requirements to improve how companies manage cash flow. There are a host of longer-term reasons to focus on cash flow, including opportunities in emerging markets, the renewed focus by credit agencies of firms’ internal capital flows, and the growing complexity of business organizations, which tends to breed more inefficiency and tie up more cash rather than less.

To achieve sustainable cash flow improvement in the current environment, business managers need to go back to basics and start to think about how to manage the business more around cash. The key is to attend fastidiously to detail – to the processes, policies, and people that define cash and working capital performance. With these in place, the business can then focus on driving cash flow improvement from working capital and other areas of the business.

There are four key areas that form the foundation of successful and sustainable cash flow improvement: • Accurate cash flow forecasting and monitoring • Timely and fit for purpose management reporting • Targets and incentives aligned across functions • Clear roles, responsibilities and ownership of cash

CASH FLOW FORECASTING AND MONITORING Visibility and control of cash flow is a vital step to creating the right framework for managing cash. According to a recent survey carried out by CFO Europe research in association with KPMG, this is where many organisations are failing at present. Only 14 percent of respondents said their cash forecasts were on target over the last 12 months. The inaccuracy of forecasts is only part of the problem, however. Many companies don’t use the metric as a part of their assessment of operational cash performance. And they fail to get buy-in from business units outside the finance organization.

To make forecasting more accurate, managers should ensure that they establish a clear reporting format, define who is accountable for reporting the relevant numbers (this is not just finance), and challenge and review submissions to encourage continuous improvement.

Monitoring of actual cash flow against forecast is equally important, and an area in which many businesses fall short. If variances against forecast are not investigated the forecasting process can only ever be of limited use and management will never fully understand the cash flows within the business.

It is only through this sort of focus that organizations can hope to improve a crucial aspect of their working capital performance.

TIMELY AND FIT FOR PURPOSE Focusing on the cash cycle across functions and seeking to ensure a timely and accurate flow of information is critical to enable rapid responses to market conditions. The finance organisation needs to engage all parts of the business, driving awareness of the importance of cash and working capital management. Without alignment across all functions finance will merely be reacting to challenges as they arise rather than proactively planning how to manage issues with minimal business disruption. Given the speed and severity of the slowdown in economic performance, companies should be acutely aware of the risks related to the financial health of their own customers and suppliers. Sales and purchasing need to maintain active dialogue with customers and suppliers to assess the potential risks and finance needs to be engaged to manage exposure.

ALIGN TARGETS AND INCENTIVES Achieving sustainable improvement over the long term requires cash management to become a natural part of every day life for everyone in a company. This means the cash flow impact of decisions is considered in addition to the sales and/or profit effect. And that targets, reporting and incentives all have cash and working capital elements.

Many businesses still link sales commissions and bonuses to sales made rather than to cash collection, which in the current economic climate may result in sales being delivered by the sales force at a cash loss to the business.

ROLES, RESPONSIBILITIES Roles and responsibilities for cash and working capital need to be clearly defined across the business, and the right policies put in place to govern behaviour. The key to success is to ingrain a cash culture within the organisation. But changing from a profit focus to a cash culture can take a long time and is by no means an easy task. To succeed requires sponsorship and full commitment from the very top level. And it is essential that, when initial cash gains have been achieved, clear long term objectives are set to ensure the focus on cash remains.

Our experience shows that cash management programmes that succeed are those where the organisation has driven the programme from board level and ensured the focus on cash has remained throughout. Cash needs to be incorporated within the strategic decision-making process of the organisation and cash management has to become a normal daily activity and the responsibility of managers across the organisation if lasting success is to be achieved.

BEYOND WORKING CAPITAL To deliver maximum cash flow improvement it is important to look beyond working capital initiatives and explore non-working capital areas, involving restructuring of the balance sheet and right-sizing of the company’s operations. Such balance sheet restructuring measures might include disposal of non-core or surplus assets, sale and leaseback arrangements, and deferral or re-phasing of capital expenditure programmes.

Other cash opportunities might exist from a review of the tax accounts, including the timing of indirect tax payments or reclaims, or from a review of the business’s banking structures and facilities, including pooling structures and operation of overseas accounts.

At a time of falling interest rates, consideration should be given to interest rate hedging strategies which provide certainty over specific cash flows.

The breadth of opportunities will depend on the business, but our experience shows that there will invariably be cash, and often significant amounts, trapped within the balance sheet.

CHALLENGE OR OPPORTUNITY? Though the credit crunch may not feel like a blessing for finance departments, it does present an opportunity to push through reforms to how companies manage their cash and working capital. With cash in short supply, now is the time to consider installing the processes and procedures to sustain improvements over the longer term. Once normality returns, and credit is available again, the temptation will be to revert back to bad habits. The task for many finance departments in the years ahead will be to try to ensure that doesn’t happen. Businesses which take a ‘back-to-basics’ and structured approach to cash management will be the winners, releasing cash from their businesses to provide financial flexibility, and using the opportunity to embed cash into the culture to ensure a healthy balance between cash and earnings when economic prosperity returns.

Alan Morris is head of KPMG’s Cash Management team.