Over the past few weeks I’ve talked about the vital importance of cash for businesses as we continue to grapple with the effects of the pandemic. Government support and intervention has provided vital support over the summer but before long, money will need to be repaid. It’s going to be a bumpy few months but focusing on cash will help to protect businesses from whatever lies ahead.
That means creating a genuinely cash conscious business – but that’s easier said than done. In my experience, some common misconceptions around cash can get in the way. Here are the ten I see most often:
P&L and cash are fundamentally different. The former is an accounting concept, the latter is tangible and sits in your bank account but the key difference is timing. Cash matters, especially in times of crisis - the most efficiently managed cost programme won't help if cash runs dry. Ultimately the cash goal is maximising the available cash in your bank accounts so that key expenses can be paid. Each business will have its specific key challenges but to achieve this goal will include a combination of the following:
A cash-conscious culture must come from the top of the organisation. It’s up to the CFO to set the tone on cash, challenging departments and geographies about their cash position while supporting treasury to manage, centralise and report cash effectively. If the CFO cares, everyone cares.
Once someone in a business commits the business to paying out money, the only option left in terms of cash management is to stretch creditors. Cashflow needs to be controlled at its source – that means making sure that everyone prioritises cash, and that processes are in place that examine expenditure and assess that any future expenditure adds real value to the business.
The reality is that the people who really know what’s happening with cash in the business are those on the front line. On any particular day, finance and treasury will be watching bank accounts, moving cash around and making decisions on where the organisation’s cash is held and in what currency. They can forecast only the treasury-related flows accurately. But on that same day, if a batch of essential parts in a factory in Spain fail a quality control test, it’s the factory manager who will know when the problem is likely to be fixed, how long the stock will be held up for, and when it will be sent to the customer affecting cash receipts. It’s essential that information from people like this is fed into cash forecasting, by mapping those with the best view of cash in the organisation and designing a process that feeds their input into forecasting both locally and centrally.
Scenario planning provides a cash early warning system by helping the business understand and flex its cash position in the face of uncertainty around COVID-19, Brexit and more organisation-specific issues. But in such a volatile environment, the minimum cash position will need a reset – a zero line is far too late. Setting flags in the critical ‘amber’ zone above a rebased zero line provides clear warning of approaching danger and will allow time for action.
In a cash conscious culture, there is a regular dialogue about cash across all functions and cash is considered in every decision that’s made. No-one commits the business to expenditure unless it’s essential, the timing of cash outflows is a priority in the negotiation of every contract, and anyone feeding into cash forecasts is regularly challenged on their conclusions. These conversations don’t happen by accident – it happens because cash is put on every agenda.
Foreign exchange is important and to be effective in management of foreign exchange swings one needs to improve the forecasting accuracy in Short Term Cash Flows (STCF) in the outer periods. Cash is not just in GBP - businesses are often international and have cashflows, cash and debt in many currencies. Many manage their FX risks by hedging using either derivatives or attempting to net off positions and flows. However, an effective short term hedging strategy is only possible when the business has a high level of accuracy of their short term cash forecasts for the whole 13 weeks, not just the first four or five. Having an accurate cash forecast enables the finance function to take agile decisions on hedging and money markets investments while safely preserving minimum cash balance and covenant compliance in times of high markets volatility.
Treasury and cash teams have a key coordinating role in the effective management of cash. They see the cash in bank accounts, can see movements in cash balances and manage the foreign exchange and banking facilities. An effective team uses this information to help the CFO and operational teams challenge themselves on the use of cash and forecasting of cash and manage cash usage against limits and targets.
By regularly reviewing tax-adjusted P&L forecasts in order to calculate corporation tax quarterly instalment payments (QIPs) businesses will ensure cash is maintained in the company by avoiding overpaying tax and having to wait to reclaim it from HMRC. Similarly, by maintaining provisions of cash to avoid any cash ‘shocks’ should uncertain tax positions be challenged by HMRC, businesses can maintain cash in the company.
Undertaking regular reviews of all available reliefs and exemptions may help to either preserve cash outflows or to recover tax that has been previously paid (examples include R&D relief, capital allowances, tax losses carry back claims, utilisation of double tax treaties, Time To Pay Arrangements).
Ensuring that your tax function is both digitised and integrated into all functions of the business, not only the treasury function, can help provide real-time updates on expected tax positions allowing for greater cash planning. A key example of this can be regular reviews of VAT inputs and outputs to mitigate any over/underpayments. However, it is still imperative to factor in tax implications in all treasury decisions, as these can have signiant cash-tax related consequences (examples include interest deductibility, treatment of foreign exchange and the usage of functional currency).
The changes to crown preference from 1 December 2020, reinstating HMRC as a secondary preferential creditor in respect of certain taxes (including VAT, PAYE and NICs), may have a significant impact to a companies' creditors and debts and should be discussed in order to prevent any immediate shocks to a company's working capital cycle.
Working capital management is a simple concept in theory but in practice it touches every part of the organisation. A consistently defined hierarchy of working capital KPIs from management to operational level, with assigned accountability and responsibility is a good place to start.
This drives focus and helps each part of the business understand their role. For example in the Order to Cash cycle the sales function sets in stone much of the downstream working capital profile at the point of contracting. However, a top line focussed sales force may not necessarily have cash front of mind or have the right tools and awareness to make an optimal trade off which finance can support. The same dynamic often plays out where procurement (Procure to Pay) and supply chain (Forecast to Fulfil) functional silos can distract from the cash goal. With COVID and Brexit injecting more and more volatility, it’s more important than ever to ensure operational teams are equipped with visibility, capabilities and tools to manage working capital in their day to day roles.