FD Report: Go with the flow - getting to grips with cash flow forecasting

On forex risk, Stebbings cautions against finance functions developing too much of a trader mentality. Keep things simple, he advises and hedge only when you fully understand why you are hedging. “Do not think about which rates are going to be moving up or down in ways that might be advantageous or disadvantageous. Think in terms of what your payments need to be made in and what your underlying exposures are, then, if the business need dictates, use straightforward instruments.

Ask the question: why hedge if, for example, you have a dollar exposure resulting from imports into the UK? There may be sound operational reasons to hedge. These might be to protect a covenant or the fact that you have an ability to change prices with, say, a six-month lag, or you can change your source of supply within the hedge period. But hedging costs money and it is not a “no brainer”, he says.

“The name of the game for FDs and treasurers today is capital preservation. This is about survival, not about making a few basis points on a deal,” he warns.

Stebbings points out, too, that FDs should also think long-term and include foreign exchange in the bigger picture when they are looking at operational decisions. A classic example, he points out, was outsourcing manufacturing to China. “That is a play, ultimately, not just on labour costs, but also on the US dollar against the pound. With the pound weakening heavily against the dollar, the cost of outsourcing to China has gone up very significantly. This was potentially foreseeable and may not alter the decision, but how many companies took it into account when making their decision?” he asks.

Alan Flower, a director in restructuring at KPMG, agrees. But he points out that FDs need to take into account shareholder expectations as well. Some transport companies, he notes, were heavily criticised for trying to hedge out the price of oil by taking forward contracts. When the price of oil fell dramatically, those deals no longer looked smart. But the companies were right to look to take commodity price risk out of the equation. They are in the business of haulage, not in the business of commodity trading ­ and their shareholders should not want to see commodity price risks playing a huge role in the share price.

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“Working capital risk management is at the top of most boards’ agendas in the current climate,” says Grant Thornton’s Best, “with the majority making considerable efforts to understand their cost, debt and cash flow positions and looking to ensure that their working capital is being deployed in the most effective way. They are taking stock of their funding and renewal positions and considering a range of tightening scenarios and the associated contingency plans and funding options.”

He points out that management needs to understand and manage any operational commitments or outflows which may impact or breach banking covenants and pledges.

Operational line managers, for example, could sign contracts which make eminent sense in terms of their own projects and remit, but which inadvertently breach undertakings the company has made with its bankers.

Both Best and Sage agree that it is essential for corporate treasures and FDs to reach out into the operational side of the business in times like this if they want to fully understand and manage cash movements and commitments.

There may also be situations in which the company has price contracts with suppliers which contain contingent elements and clawbacks related to market variables ­ commodity prices for example. The recent market turbulence has created situations where trade creditors have moved into a receivable position and created doubtful debts as a result of market price movements. All this means the finance function has to be involved in the transactional aspects of the business and ensure that operational managers understand the financial obli gations which may impact upon their activities and decisions.

E&Y’s Sage says that of all the companies he works with, there are very few that he comes across where the treasury system is closely and robustly managed to the operational cash system. “Treasurers measure their major cash requirements, inbound and outbound, of course, but they miss the swings that occur in operational cash flows.

This side of things is just not as actively managed as one finds with major capital and investment flows.” He points out that some private equity houses are starting to raise the bar on cash management and are looking to put all their operations on rolling 13-week cash flow forecasts. “At a time like this, organisations benefit hugely from getting cash fit.

You have to have visibility and you have to get the management team engaged and operating to deliver the best possible visibility and predictability,” he says. The upshot of this is that operational risk remains something that organisations need to focus on as far as cash is concerned.

PwC’s Stebbings is another who warns that there is huge pressure on FDs to get much more accurate cash flow forecasting in place. Basically, the fundamentals are simple: understand where your cash is coming from and when you have it, manage it as effectively as possible, while mitigating risks before you spend it. Easy to say, fiendishly complex to execute.