The largest enterprises are prioritizing financial risk over cash and liquidity management, a recent study has shown. The findings underline not only the important role of treasury in managing financials risks, but also the pressing need for treasury to have complete visibility into the risks to which their organisations are exposed.
More than 250 treasury and finance professionals were questioned in the research from Kyriba and the Association of Corporate Treasurers1. The results showed that among the largest companies (those with revenues in excess of £10bn), cash management emerged as a relatively distant second priority to risk management.
In all, risk management was the top priority for 40% of respondents, with that percentage jumping to almost 50% for companies with revenues of more than £10bn.
One major factor underpinning this ongoing focus on risk is the financial climate, which continues to leave corporate assets and financial contracts increasingly exposed to risk, and can make the treasurer’s role more difficult than ever.
External events, such as political uncertainty in the eurozone or the latest growth data released by China generate an almost immediate impact in financial markets. This in turn impacts the value of cash flows, financial positions and business contracts.
Achieving the high level of visibility needed to meet and improve risk management invariably requires a continuous journey of effective decision-making. In most cases, a hierarchical, step-by-step approach is necessary to reach the goal, beginning with a renewed focus on daily cash visibility.
The need for visibility over global cash flows
As a starting point, getting to grips with cash visibility requires implementing daily reporting of a company’s bank accounts – wherever those accounts reside – is paramount. Daily frequency is the minimum, of course, as organisations will actively position cash throughout the day.
Regardless of the number of daily updates, the mechanics are straightforward. Banks feed daily files or messages to corporate customers via direct file interface (usually using FTP), via a banking network/protocol such as EBICS, or leveraging the SWIFT network.
For most organisations, automation is necessary to achieve reporting accuracy as well as ensure information is timely. Timeliness is especially critical, as delays in achieving visibility inevitably lead to money movement (or money protection) decisions being further delayed.
To be effective in risk management, the treasury needs to know which streams of cash flow are exposed to which risks.
Those risks may be as simple as fluctuations in currency exchange rates. Alternatively, it may mean diversifying cash from over-exposure to bank counterparties, or leaving pockets of trapped cash unable to meet obligations in different banks or geographic regions.
Whether currency, counterparty or liquidity, risk is the concern, gaining visibility into global cash is paramount to making effective risk management decisions.
Timing matters in liquidity visibility
Cash and liquidity are often talked about as one decision. While they are commonly linked, cash and liquidity decisions can be independent, depending on the complexity of the organisation’s banking and funding structures.
If all cash is swept at the local level and physically centralized into corporate accounts, cash and liquidity are arguably one decision. Excess cash is invested and shortfalls are funded, often automatically. In this scenario managing liquidity risk is a straightforward process.
International treasury operations require different – and often more complex – decisions. As a result, visibility is needed into not only cash but also into the costs and barriers of moving cash between regions. In some cases, it is actually optimal to retain pockets of excess cash in one region while raising cash in other countries (much like Apple did to satisfy shareholders’ demands for dividends). Therefore, to be efficient, the treasury team must have both visibility and understanding in order to make effective cash and liquidity decisions.
Future cash forecasting: confidence matters
Visibility into future cash flows is one of the most important risk management tools that a treasurer and CFO can have. Having confidence in the forecast not only provides insight into risk but also helps protect against risk factors. Unfortunately, lack of accuracy is also one of the primary deficiencies of most forecast processes.
One example to illustrate the importance of forecast accuracy is with hedging programmes: while most treasurers and cash managers feel confident in their forecast of cash flows one or two weeks out, developing a hedging program for only the next fortnight is insufficient as proper risk management requires longer-term decisions be made.
Yet, the costs of over-hedging are high given the accounting requirements of whichever of the International Accounting Standards Board (IASB), Financial Accounting Standards Board (FASB) or International Financial Reporting Standards (IFRS) that the organisation must comply. As such, treasurers are effectively forced into under-hedging exposures three, six, nine and 12 months out – a classic symptom of not having sufficient confidence in the cash forecast.
Cash forecasting also offers protection for other risks, including supply chain risk. The ability to more accurately predict revenue streams from various customers will in turn help predict expanded requirements of the organisation’s supply chain.
While this analysis will help protect against liquidity risk, currency risk (if business is international) and help with working capital projections, insight into supply chain requirements will help identify potential business exposures. ‘If supplier x cannot meet production requirement y, we put our relationship with customer z at risk’ is a logical outcome of such an analysis.
Armed with this information, treasury can collaborate with other internal business partners to proactively take action, designing financial outreach or programmes to help mitigate against future supply chain disruption.
Completing the circle
In all, the object of risk management is to protect the value of the company’s financial assets – which includes everything from investments and cash to accounts receivable and liabilities. Without this full visibility and control, treasurers cannot fulfil their responsibilities.
In helping treasurers make better risk management decisions, treasury management technology will help them to not only design effective risk management programs for liquidity, counterparty, currency, interest rate, commodity, and supply chain risks – but also deliver more effective corporate governance by supplying detailed and accurate risk reporting.
Without exception, visibility into financial assets and risk exposures is absolutely necessary to perform this role. Here, treasury technology offers options that can make a significant difference, especially if productivity, financial controls or access to information streams are barriers to establishing visibility in the first place.
This article first appeared in Banking Technology.
1. Using Technology to Drive Strategic Treasury – the Changing Role of the Treasury Team