Robust cash flow forecast
In times of uncertainty, it’s even more important for an organisation to have a proper grip on its liquid assets. A robust cash flow forecast provides a clear picture of the future liquidity position and offers a platform for informed decisions on how to control the liquid assets and any measures necessary. In this article, Edwin van Wijngaarden, Business Recovery Services partner at PwC, discusses the critical success factors for an effective grip on liquidity.
Edwin van Wijngaarden
Podcast
In this podcast (in Dutch), Edwin van Wijngaarden, Business Recovery Services partner at PwC, discusses the critical success factors for an effective grip on liquidity.
Phoney focus on liquidity
A crisis like the present coronacrisis is something Edwin van Wijngaarden has never before experienced. As a partner in PwC’s restructuring practice, he daily assists companies in need, but could a company have made any preparations at all to guard against the current circumstances? “Asking the question,” says Van Wijngaarden, “is tantamount to answering it. But what strikes me is that companies often overestimate how well they have their liquidity under control. Even if they do have a cash flow forecast, it’s for the sake of having one. But actually using it to make conscious decisions based on it… well, in actual practice that’s very disappointing. And that’s not to mention the companies that don’t have any forecast at all. So there are companies that don’t focus at all on their liquid assets and there are companies that think they do focus, but that don’t in fact pay enough real attention to them. And then they may well come in for a nasty surprise. That’s unnecessary, because you make that forecast above all for your own organisation in order to get a proper grip on your liquidity. The forecast is a means rather than an end.”
Tools and processes
Having an effective grip on liquidity consists of two important components, tools and processes. “What you need on the one hand”, Van Wijngaarden explains, “are the tools to be able to do something. You need a template in which the various business units, divisions, or subsidiaries can fill in the forecast so as to arrive at a consolidated picture. That can be done using an Excel model or in an app that’s fully integrated into the organisation’s planning & control systems.
It’s important that the model you use is geared to the specific situation of the company and the insights required. On the other hand, you need a process that allows you to arrive at that forecast. Because what you often see is that a company does have certain tools but that the process side of its cash flow forecast is still too much of a “finance-fest”, for example, controllers throwing something together without properly involving the business or ensuring that the business actually takes ownership of the forecast. Only with this last step do you introduce 'cash thinking' into the organization and realize a different culture together.
So you also need a clear process in which the results are also discussed. You don’t very often see a process in which there’s a weekly session at the right level to coordinate the results. What it’s all about is whether you understand what’s happening within the company that affects liquidity, and do you have it under control? Because after all, the ultimate goal is not to have a new forecast but to take timely action and make the necessary adjustments. That still happens far too infrequently in actual practice. When we ask companies why things have turned out differently to what they expected, they very often don’t know the answer. That’s weird, of course. Let’s suppose you discover that a certain debtor hasn’t paid. Why hasn’t he paid? Is it because he really couldn’t pay? Or is it because you, as a company, didn’t carry out a certain action that you had agreed you would carry out? That’s an important indicator of course, because if it keeps recurring within a particular business unit, you’ll be forced to conclude at some point that that unit is focusing on the money a bit less tightly than you’d hoped.”
Critical success factors
“There are a number of critical success factors for a robust, accurate, and timely cash flow forecast”, Van Wijngaarden continues. "There needs to be consensus on the approach and the key assumptions used in the liquidity forecast for all business units. But it all starts with the availability of information. There must be access to the necessary data, which may require an IT solution or even manual work at first. The information needs to be precise. You have to ensure that the reported information is reliable, accurate and timely, allowing you to make rapid tactical business decisions. Reconciling the cash flow forecast with the latest medium-term forecasts is crucial and provides a great deal of insight into the quality of both forecasts. You can then quickly understand any necessary (process) improvements when drawing up the forecasts. Companies often use different systems, so tailor-made solutions may be required. It’s also important to keep the corporate culture alert and to ensure sustained attention to liquidity through management objectives. Those objectives must be clear and supported and pursued throughout the company. A robust forecast forms the basis for initiatives to improve the grip on liquidity, for example such things as further training and communication about the objectives, policy, and processes. To take the example of the present corona crisis: there are so many schemes worldwide that you can make use of, but how do you as an organisation know that all your divisions or subsidiaries are making full and timely use of these schemes? Or do they perhaps simply expect the parent company to take the initiative? Communication and coordination is therefore very important."
Communication and transparency
Once the liquidity forecast has been reconciled internally, the next step is communication with stakeholders. That’s a step that mustn’t be underestimated; it means more than just communicating a pile of numbers and a curve; after all, the forecast is a means not an end. Van Wijngaarden again: “Not only must it be made clear what the differences are compared to the previous forecast, and what has caused them. You also need to provide an insight into the risks and opportunities, because the forecast – no matter how carefully it’s been drawn up – is never going to turn out exactly the way you want it to. The question is how transparent you are vis-à-vis all the parties involved. Companies are often extremely cautious about being transparent, but they do need to be so. Because if things go in the wrong direction, do you want your stakeholders to be surprised or do you want them to have already been able to allow for that turn of events? In general, stakeholders will be highly critical of the management and ask whether it has sufficient control of liquidity.”
"The real question is whether you want to be an ostrich that hides its head in the sand or want to be able to say later, I may have done a bit too much that subsequently turned out not to be necessary, but that’s still better than doing too little and ending up insolvent."
Work on the basis of different scenarios
The need to work on the basis of different scenarios is now indispensable during the coronacrisis. But what scenarios are conceivable for identifying the impact of the coronacrisis on the markets in which the organisation operates? “PwC is looking at three scenarios”, says Van Wijngaarden, “ although of course there are more that can be devised. The first scenario assumes a temporary dip and a very rapid recovery. In the second the dip takes somewhat longer but we also get back to the previous situation. The third scenario indicates that we won’t be able to return to the previous level of economic growth in the short term. I don’t find it surprising that recovery will probably take a long time. An organisation that needs a lot of investment will now have to postpone that investment, because that’s how to free up money in an easy way. But not investing will have an effect on our economy. In addition – and in my opinion that effect is being underestimated – organisations will emerge from the corona crisis carrying even more debt. Because even though you can postpone remitting your payroll tax or can get an emergency credit, you’ll still have to pay that money back. And if economic recovery is disappointing, will you still be able to meet your obligations as an organisation? A lot of companies had already reached their maximum debt ceiling. So this is an important question that entrepreneurs must ask themselves before they take on additional debt, also from the risk of directors' liability. Seeking timely legal advice is crucial.
Listen, I don’t want to come across as a doom-and-gloom merchant, but entrepreneurs – and that’s commendable – often assess a situation very positively and sometimes underestimate the reality, including in times of crisis. It’s often because of our human tendency to think that everything will turn out to be OK. I understand that, because it’s also hard to confront yourself and your organisation with a negative scenario. It’s not easy to say that maybe we’re facing a much bigger problem than we think. For a lot of companies right now, it seems that a very good starting point is the old adage ‘prepare for the worst, and hope for the best’. Because the real question is whether you want to be an ostrich that hides its head in the sand or want to be able to say later ‘I was better safe than sorry'; I may have done a bit too much that subsequently turned out not to be necessary, but that’s still better than doing too little and ending up insolvent."
"You make that forecast above all for your own organisation in order to get a proper grip on your liquidity. The forecast is a means rather than an end.”
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