Can cash management make your company rich? Sadly not. But it can unlock capital, transform your bottom line and safeguard your future in uncertain times.
Every time the price of gold soars, you should ask: is your company managing its cash properly? You can’t manage it as badly as Croesus, the rich, smug king of Lydia from 561 BC to 546 BC. Assuming his revenue stream would never dry up, he let guests take home as much gold as they could carry and paid for his hubris, losing his throne in battle.
Not being as rich as Croesus, most businesses are more cautious. But in good times, firms seek growth and profit. A sustained rise in the price of gold, often a precursor of higher interest rates, is a useful warning that the business cycle is reaching a point where turnover is vanity and cash is sanity. But this change is a great opportunity. Between 2003 and 2005, KPMG member firms helped 30 companies, with turnovers ranging from U.S. $51m (€31.9m) to U.S. $14bn (€8.9bn), release U.S. $2.2bn (€1.4bn) in funds just by changing the way they managed cash.
Mick McLoughlin, Global Head of Restructuring at KPMG and partner in the U.K. firm, says: “As the economy slows, those funds could give businesses a competitive edge, so they may not have to do all the usual things firms do when they fear recession — slash R&D spend, trim marketing budgets, lay off staff. In tough times, companies that generate cash are well placed to acquire at bargain prices.
“There’s nothing new about reducing the amount of capital locked up in a company. But this has often been subordinate to other objectives, such as sales and profitability. Because of that, the potential for improving cash flow often remains under-utilized.”
To leaders inspired by the ‘vision thing’ cash management can sound like a laborious, complex task, involving huge IT spends. Not true. Simple steps can produce simple gains. Here are eight factors to consider as you focus on cash.
If your CEO doesn’t think cash is important, neither will other managers, no matter how vocal your chief financial officer is. Andrew Ashby, restructuring director at KPMG in the U.K., says: “Good cash management can uncover hidden process inefficiencies across the business, but if you don’t get buy-in from every department, you will only find out about problems when they become too obvious — and expensive — to ignore.” How good you are at managing cash is partly driven by the caliber of information at your disposal so every department — from sales to manufacturing to that subsidiary you recently opened in Taiwan — should get with the program.
Warren Buffett’s businesses generate cash because he has made this drive part of their corporate culture. He invests in easy to understand firms that have what he calls a ‘moat’: something that gives them a clear advantage over others and protects them against competition. But he only buys a business if it has the right projected cash flow per share over five years, and advises managers that sometimes the obvious thing to do with cash is the wrong thing: “Often it’s a mistake to invest money where you’ve earned it. Truly great businesses, earning huge returns on tangible assets, can’t reinvest a lot of their earnings internally at high rates of return for an extended period.”
Used to buying indebted businesses, private equity firms spend the first 100 days of an acquisition estimating how much cash they can generate without hurting the business. This isn’t just to pay off debts, it’s about improving working capital to grow the business’s value on a three to five year plan.
Much of what private equity firms do is obvious — like tightening up on receivables or extending payment terms — but their focus makes it easier to spot units generating marginal amounts of cash — perhaps a pet project of the ex-CEO — and shut them. New ventures have to meet tougher criterion on cash generation to get the go-ahead.
The spreadsheet’s day is over. Treasury information systems help firms draw on and study a wider range of data to forecast more accurately, improve financial reporting and make better decisions. But Ashby says choice and sophistication come with a risk: “Firms sometimes find new systems don’t make that much difference to their cash management. That may be because the technology isn’t right for their business, and staff can’t use it properly." Many technology solutions are sold with a fine array of features and benefits and a promise to repay their cost in a year. But usability is key. If the system is so complex staff have to be reminded, cajoled and threatened to use it, you just waste money.
Managers can rationalize procrastinating about cash management by arguing that the perfect integrated information system isn’t on the market yet though its release — as is usually the case — is imminent. Debtor listings, contract reviews and robust cash flow forecasting can all enhance liquidity and don’t require you to spend a cent on IT.
Before the industrial revolution, entrepreneurs usually had a precise grasp of what was coming in, going out and when. If they didn’t, they went bust. In a fast-moving, globalized economy, accurately answering those questions is much harder. That’s why so many companies turn to cash forecasting.
The bad news about cash forecasting is that you are likely to get it wrong. Every company’s future is partly a tale of the unexpected, so cash forecasting can never be a science, just a subtle art. But you can reduce the margin of error. Forecasts often fail because the appropriate stakeholders are not engaged and held accountable for reviewing the accuracy of their inputs and documenting their assumptions. Finance departments are too stretched to resource the task properly, or take so long finding data that they can’t study it carefully. If the data comes from your enterprise resource planning system, emails, spreadsheets and conversations, you may struggle to drill down deep enough to find out why a specific forecast was wrong and rectify the flaw.
Cash flow forecasting is so complex that Dr Mark J. Garmaise, assistant professor of finance at the UCLA Anderson School of Management in Los Angeles, says 40 percent of firms centralize forecasting: “That way a small number of employees at HQ can focus all their time on forecasting, becoming expert at managing new techniques to generate superior forecasts in less time.”
Centralization has drawbacks. Garmaise says: “The forecaster is remote from necessary local information. Transmitting local information can be difficult.
Cash forecasts — let alone business forecasts — are too crucial to be clouded by internal politics. A 2007 report on forecasting, prepared for KPMG International by the Economist Intelligence Unit, found that only one percent of the 504 firms surveyed met their business forecasts. Most under-forecast, believing this to be cautious and appropriate, but if you’re too conservative you may fail to meet demand. Some 44 percent of respondents believed pressure to match forecasts to targets made them less accurate. Forecasting correctly is hard enough. If staff feel obliged to manipulate data to fit head office preconceptions, it becomes impossible.
“In the old days, some companies thought improving cash flow was as simple as writing to suppliers to inform them you would be extending your terms of payment,” says Ashby. “But just squeezing your supply chain can be dangerous.” So dangerous, it could kill your business. In 1994 the U.S. company Aris Isotoner tried to save money by closing its Manila factory and outsourcing the manufacture of 27 million gloves and slippers to third party suppliers elsewhere in Asia. Sales halved as quality plummeted, deliveries became less timely and production costs actually increased by 10 percent. By 1997, Aris Isotoner had incurred operating losses of U.S. $123.6m (€78.4m) and was sold by its parent, Sara Lee. So if you want to squeeze more cash out of your supply chain, don’t dictate to suppliers, work with them.
Cash is king but checks and banknotes don’t help cash flow. Electronic payments speed delivery of money and, by paying promptly and electronically, you should be able to negotiate lower prices with suppliers. Energy utilities use dynamic discounting by offering consumers a small discount on their next bill if they pay quickly. Most firms plug electronic card payments into treasury information systems, so it is easier to spot anomalies.
The shift to electronics can yield real dividends. In 2000, one U.K. business found it was missing the chance to bill for U.S. $2.75m (€1.75m) of sales a day because it was posting proofs of delivery to clients. It soon switched to electronic versions.
Cash flow management isn’t a short-term fix for firms at risk, it can be the discipline that drives the growing value of a business. “Those that are very good at this — like Mittal Steel and Buffett — have a cash culture,” says McLoughlin. When Mittal bought a Mexican steel mill in 1992, it instituted a daily meeting where heads of department discussed costs and volumes the previous day, instilling a discipline and focus mill managers would never forget.