Bancorp Treasury Services Limited

Make Risk Count.

CASH – THE BUSINESS NUTRIENT

05 November 2009

We’ve had the crisis. Now it’s time for the recovery – or so everyone hopes.

Many difficult decisions must be made when planning how best to profit from renewed growth. Tight budgets create extra impetus to improve efficiencies, and to do more with less. All to often businesses overlook the most obvious solution: effective and efficient cash flow and credit management. Streamlining the way money moves through the organisation can make the difference between flourishing – or fizzling – economic green shoots.

The first step requires involving all departments (not just the finance team) in thoroughly reviewing how, when and where cash comes into the business, spends time, and exits. Such a review brings four distinct benefits:

  • Improved efficiency reduces operational costs and keeps working capital to a minimum.

  • It provides an opportunity to revitalise and improve relationships with favoured suppliers and customers and, if appropriate, to slim down the number of counterparties to a more manageable number (the 80/20 rule may kick in).

  • Better understanding how cash flows through the business improves the quality of cash flow - and general business - forecasting.

  • A more robust attitude to cash monitoring, controlling and forecasting will aid better organisational governance by improving information quality. Management is less likely to be caught by surprise squeezes on liquidity, and it may even reveal (or prevent) instances of internal fraud.

Check bank fees. Start by ensuring clarity and transparency on what fees are currently paid. Itemise them and perform a reconciliation to prove that the bill is correct. Negotiate with banks to reduce the fees and/or improve processes. In most cases the savings outweigh the review costs. It may become clear that the time is right to consider changing banks.

Cash management may seem like stating the obvious, but many organisations pay insufficient attention to it. Running out of cash causes more business failures than does poor profitability. Keep cash in the right place at the right time, throughout the economic cycle by understanding how it enters and exits the organisation. This knowledge will help management to sharpen process, creating hard dollar savings. Streamlining cash and credit management requires discipline and attention to detail.

Ensuring effective cash and credit management requires an organisation to develop and support a culture of regularly reviewing its cash flow and credit management practices and processes. Always look for better ways of doing things; review invoicing and accounts payable procedures to streamline, simplify and rationalise wherever possible.

This groundwork creates a firmer foundation to plan for growth to come – yet the planning stage requires extra care. Ongoing economic uncertainties mean that wherever possible, remain flexible and avoid committing to something that may not eventuate.

This is especially true for interest rate risk and foreign exchange rate risk. Hedging such exposures is generally wise, but business volumes and prices cannot be predicted accurately so avoid using interest rate swaps or forward exchange contracts to lock down more than an appropriate portion of the expected sums. The growth element of your forecasts is even more variable and won’t happen at the same time as currency and interest rates are most in your favour. Use hedging strategies that bridge the gap.

Option-based strategies can be ideal when both volume and price are uncertain because they provide protection without commitment. Purchasers may choose to deal at whatever is the better rate on the day of the option’s expiry – either the option’s strike rate or the market rate. There is no commitment to deal, which is ideal if the underlying business hasn’t happened or if the market price has improved and the business wants to take advantage of the new levels. Buying an option doesn’t use up bank credit facilities either.

New Zealand companies grossly under-use options. Sometimes it is a straightforward lack of awareness of how these instruments work, or even their existence. Sometimes it’s an inhibition against doing something a bit different. Sometimes it’s a belief that they are not value for money. And sometimes the accounting gets in the way.

These objections are not insurmountable and it is pleasing to see that the main New Zealand banks have recently tried to improve the situation and encourage their customers to use options.

As recovery replaces crisis, the future is up for grabs. Businesses need to be lean and trim, yet ready for growth. Cover the risks of growth, but commit to as little as possible. As your business blooms, don’t forget to water what you have already planted – good discipline on cash and credit management.

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