Getting a grip on the cash strategy

When a positive operating cash flow is realized, it is easier for a company to invest in acquisitions, fixed assets and innovation, for example. On the other hand, a negative operating cash flow can be an indication that the survival of an organization in the long term may be at risk. Therefore, a reliable cash flow forecast is of strategic importance for every organization and deserves attention at board level as well.
In one of our other articles about cash flow forecasting, we focus on information, processes and systems that are needed to come to an accurate cash flow forecast. In this article, we focus on the strategic side; which stakeholders, agreements and steering possibilities play a role to keep a grip on the cash flows in the long run?

STAKEHOLDERS

Having sufficient liquidity in the long run ultimately means continuity for the company. Internally, not only management (Board of Directors) but also the Supervisory Board (SB) is responsible for this. Large investments often have to be approved by both. They will therefore want to be informed well and in time about the expected development of the liquidity position in the short and longer term. After all, if a cash shortage threatens, directors' liability comes into play. The management board may not enter into any new obligations if it can reasonably assume that the current creditors cannot be paid (in the short term).
In some cases there may be a public shareholder. For them, insight into cash flows and the development of liquid assets is of great importance. After all, if a cash shortage is imminent, the shareholder is often the first to be approached to supplement this.
A company also has to deal with external stakeholders. The most important are often the financiers and the auditor. Financiers can be banks, but also ministries (through treasury banking) or care offices (funding). The financiers usually monitor the financial health of the company using various ratios and covenants. The liquidity position is very relevant here because, among other things, it gives an indication of the extent to which the organization is able to repay the outstanding loan(s).
Finally, the auditing external accountant follows the liquidity position with above-average interest, because when auditing the financial statements he must issue a continuity statement, among other things. This is only possible if there are sufficient liquid assets to meet current liabilities for at least 18 months in advance.

APPOINTMENTS

Internal agreements focus mainly on the frequency, timing and type of cash flow forecast. In calm, predictable times with an ample liquidity buffer the demands are different from those in uncertain, turbulent times. This therefore requires a different set-up of the organization. During predictable times and when there are no major investment plans, a good understanding of the liquidity position is still important, because it affects the amount of funding to be raised or the deployment of funds, for example.
However, in that case the frequency of forecasting does not have to be weekly, the timing is less strict and the indirect method suffices (in which the cash flows originate from the P&L account and the balance sheet. This method therefore also includes the cash effects of balance sheet changes). Reporting to management board members also takes place less frequently. However, if the company is in dire straits, this will not be sufficient and the frequency of the forecast and the reports will have to be increased. Moreover, the time horizon will be longer.

"In addition to making arrangements to make cash flows transparent, it is equally important to know what tools a director has to prevent a cash shortage."

The ability to attract additional funding is largely determined by the extent to which the organization is able to provide the necessary insight into, and correct substantiation of, the cash flows, assuming sufficient repayment capacity. This means that extra attention must be paid to the design of the processes, the mutual communication and the quality of the available data. Although these are matters that must be arranged in the operational process, this often does not happen automatically. It is therefore desirable for directors to keep a close eye and at least discuss the progress made in this area with the responsible manager(s).
It is also good for directors to be aware of the most important agreements in the financing contracts. For example: when must the (un)audited annual figures or the calculation of the bank covenants be submitted; what are the consequences of breaching the covenants; what conditions apply to obtaining a waiver? Although there is a whole process involved, it is good to realize that, worst case, failure to meet certain obligations in the contract can lead to an event of default and ultimately even a loan falling due.

CONTROL OPTIONS

In addition to making agreements to provide insight into cash flows, it is at least as important to know which instruments a director has to prevent a shortage of liquid assets. Before discussing this with financiers or possible shareholders, experience shows that they will often first demand that costs and revenues be closely scrutinized. Furthermore, outside the organization additional financing can be sought from banks or a ministry.
If available, a shareholder can be asked for additional capital. Which one should be approached first, again depends on the situation. In times of uncertainty, or when the financiers have financed a large amount (this can be determined using the net debt/EBITDA or Loan to Value), it is common to approach the potential shareholders first.
After all, because of the uncertainty about the future or the size of their current exposure, financiers will be reluctant to put extra money into the company. It is important to inform shareholders during good times and to keep them informed in the regular reporting cycle. To avoid being taken by surprise, they should be informed immediately of any development that could have a major impact. If the company is doing well and investments are needed to facilitate growth, for example, the financiers can be consulted first. Whether they are prepared to provide additional financing depends on several factors (such as the nature of the investment plans and the robustness of the forecasts provided), but the basic attitude will often be positive.

CONCLUSION

The importance of understanding the development of cash flows is not purely an operational matter. Cash flows play an important role in the continuity and flexibility of the business, the ability to invest, the timely identification of risks and the determination of the value of the business. For these reasons cash flows deserve attention at board level. To obtain good insights, the relationship with internal and external stakeholders, the agreements made with financiers and the measures to adjust play an important role. In all these matters, timeliness, predictability and accuracy are key to continuity and therefore important for a director. It is advisable to continuously invest in and pay attention to these issues.