During uncertain times, making a forecast requires extra effort and poses a greater challenge. For example, due to uncertainty, it may be decided to update the liquidity forecast(s) more frequently. The question raised then is what frequency is appropriate and how to deal with the assumptions underlying forecasts made during an economically sound period. In this article we discuss the information, processes and systems that are important for getting (and keeping) a good grip on the development of cash flows. Ultimately, as an organization you want to have a reliable picture at all times of the expected development of the liquidity in the short, medium and long term.

AVAILABILITY OF THE RIGHT INFORMATION

In order to obtain the best possible picture of the liquidity position, the quality of the underlying information is of great importance. The realized and projected profit and loss account, balance sheet, investment plans and transactions form an important part of the input. From a theoretical point of view, there are two methods to translate this input into the calculation of the (expected) cash flows; the direct and the indirect method.

• Under the direct method, cash flows are based on individual incoming and outgoing transactions, such as accounts receivable receipts, accounts payable payments, investments and interest payments.
• Cash flows under the indirect method arise from the P&L account and the balance sheet. Thus, under this method, the cash effects of balance sheet changes are also included.

Which method is appropriate depends in part on the length of the specific forecast. Actual bank movements (or an accurate estimate of these), on which the direct method is based, are often available for a relatively short period of time. This makes this method suitable for a short-term forecast. With the indirect method, the cash flows are derived from the projected P&L account and balance sheet. Because of this combination, this method is ideal for medium and long-term forecasts.
The most appropriate methodology depends partly on the length of the liquidity forecasts. In order to obtain a good picture of the liquidity position in the short, medium and long term, various forecasts must be prepared. These forecasts differ in terms of time units (week, month, quarter and year) and length (quarter, year and > 1 year). The matrix below shows the different time lines again, with the different forecasts shown vertically. To the right of the matrix, the appropriate methods for each forecast are shown.

Here, it is often the case that the longer the period over which the forecast is made, the less accurate the forecast. The choices regarding time units and length of the forecast are related to the phase in which the organization finds itself and the type of sector in which the organization operates. For example, in times of economic uncertainty (such as the current pandemic) or in the case of a weak financial position, it is often chosen - sometimes imposed by external financial stakeholders (e.g. special management of a bank) - to produce a short term forecast on a weekly basis. This should ensure that the financial position is brought into focus on a weekly basis, thereby increasing the grip on cash flows.

"In order to get a good picture of the liquidity position in the short, medium and long term, various forecasts need to be made."

However, this does not mean that the financial position is more accurately portrayed by creating more forecasts of different lengths. Indeed, too many (different) forecasts generate a constant time investment that is too great to keep updating them.
When an organization is in a "quiet" period, a monthly forecast for 12 months rolling, combined with a multi-year (annual) forecast for 5 years rolling, may be sufficient. However, consistency between forecasts is crucial. The inputs provided should be consistent across the different forecasts, and the time units of the different forecasts should overlap. For example, if a 13-week forecast (quarterly) is chosen, it will logically align with the liquidity forecast of at least 12 months rolling on a quarterly basis.

EMBEDDING IN SYSTEMS

One of the tools needed to process and update all information is a system that brings together all cash flow information. In practice, a treasury module in the existing ERP system or an Excel file is regularly used. If Excel is used without a clear format, it often turns out to be too complex, confusing and prone to errors. With a clear format, Excel can certainly be a suitable tool. In addition, one can choose to largely automate the forecasting process by means of an application.
The format of the chosen system will act as a means of creating consensus among internal stakeholders on the approach and principles of forecasting. In addition, it will create clarity towards external stakeholders. In order to maintain an overview, it is advisable to subdivide the cash flows into a limited number of items. The following three types of cash flows provide the basis for this:

• Operating cash flow: all cash flows resulting from operations.
• Investing cash flow: consisting of the investments in fixed assets, investments in the form of acquisitions or revenue sales.
• Financing cash flow: all expenditures and income from financing activities (a different choice can be made with respect to interest).

TREASURYnxt provides organizations with a flexible way to create liquidity forecasts for the above cash flows. To learn more about TREASURYnxt , click here.

GETTING A GRIP ON CASH THROUGH THE RIGHT PROCESSES

Besides information and systems, processes will need to be established within the organization to really get a grip on the cash position. Fixed processes bring structure to the preparation, comparison and updating of forecasts. It must always be possible to answer the question of why a particular cash flow differs from a previously prepared forecast.
It is important to be able to explain the difference between two liquidity forecasts of different times. A clear format can help with this. The challenge lies in constantly updating and reconciling these forecasts. If, for example, an investment is postponed, this will have to be reflected immediately in the investment cash flows of the forecasts. Here, clear communication is crucial. This starts with internal communication, by means of regular meetings or calls (so-called cash calls). By scheduling regular cash calls, during which the cash position and expectations are discussed and analyzed, the forecasts remain up-to-date. It is preferable to align the frequency of these cash calls with the frequency of the relevant forecast. In communications with external stakeholders, it is particularly important to provide insight into the risks and opportunities of the forecasts that have been prepared.
Finally, it is essential to compare the actual realization of the cash flows with the forecast that was prepared for the cash flows. The deviations and insights arising from this must be taken into account in the forecast for the subsequent period. After processing this realization, the length of the relevant forecast will have to remain unchanged, a so-called rolling forecast.
Ultimately, grip on the cash position can only be realized through the combination of information, systems and processes. A clear vision on this helps to structure this interplay.

At more than 275 years old, Van Lanschot is the oldest independent private bank in the Netherlands. With an eye on the rapidly changing market, last year the bank decided to change its strategy. Evi Van Lanschot is now the young face of the oldest bank and is focusing on the wealthy client of the future.

2013 was an important turning point in Van Lanschot’s development. Under Karl Guha, the new CEO, the bank implemented its new strategy for the coming five years based on three key points: focus, simplification, and growth. “Focus means that we concentrate on what we are really good at, i.e., the retention and growth of our clients’ capital,” explains Martin Van Oort, Van Lanschot’s financial risk management director. “Over the past few years we have increasingly become a ‘small large bank’, with a business banking portfolio. As a result of consolidation in the sector, this will be scaled down even more. As a specialist and independent wealth manager, we think we can really make a difference for our clients.” Customers also wanted simpler and more transparent products. “And we want to extend this line through our organization, in our IT systems and in operations – it has to be simpler and more efficient,” Van Oort continues. “That means rigorous internal reorganization in order to serve our clients in the best possible way. The growth we strive for has to come from the capital management area.”

Synergy with Kempen

Van Lanschot and Kempen are strong labels, which enables the bank to offer a combination of private banking, asset management, and merchant banking. “This offers clients huge advantages; they enjoy an even more tailor-made service,” says Van Oort. The bank’s changed service concept is particularly visible from the outside. For the personal banking segment, Evi Van Lanschot is a clear proposition targeting starters on the capital markets. With the idea that there is private banking potential present, Evi’s entry threshold is much lower. Van Oort says: “Medical specialists and business professionals have differing requirements over the course of their careers and we can assist them in the best possible way over the whole cycle. The Evi bid is going very well; in the Netherlands and Belgium we have approximately €1 billion in savings and managed capital.”

At the same time, clients who currently belong to the personal bank but who require private banking services can – if they pay for it – choose this option. Finally, the bank has a Private Office for extremely wealthy clients. “They too of course profit from the synergy between Van Lanschot and Kempen,” adds Van Oort. Van Lanschot is parting company with another section of the bank – the corporate banking portfolio, which includes commercial real estate financing. “We will do that in a respectable and professional manner. By winding down slowly but retaining service levels, losses can be minimized and clients will have enough time to get a new roof over their heads. Running down this portfolio is going according to plan. We are taking leave of something which no longer fits in with our new strategy and we are putting a lot of effort into private banking. This gives direction and clarity to all of our stakeholders.”

Shorter lines

 All of the bank’s departments are occupied with change. “It’s going well. The shop is open during the reconstruction phase and so customer experience should also stay at a good level. Even the balance sheet ratios – solvability and liquidity – which are so important for the bank, are ahead of our anticipated long-range targets.”

The bank’s culture is changing as well: the traditional bank, where change sometimes appears to be dragging its feet, is becoming younger and more modern. Van Oort explains: “The Evi customer needs a transparent digital service, preferably with a handy fancy app on their mobile. You can see that the bank is also changing in that respect into one with a dynamic culture. For professionals who embrace change, it’s a really great and exciting time. We hear more often that people would like to work for Van Lanschot since so much is happening and we are in the thick of it. Lines are shorter and your ideas have an impact. The fact that it is going well on the personnel front is, of course, important as after all, it is the people who make the bank.”

Parallel to strategy changes, the bank is also investing a good deal in specialist staff functions. Last year it was decided to revise the bank’s risk management; as of March 2013 Van Oort is in charge of a new department – Financial Risk Management. The creation of this department, which was an amalgamation of various teams, was the first step towards further professionalizing risk management. “This second-line department is responsible for consolidated financial risk management within the bank,” he explains. “Besides setting limits and the integral monitoring of the bank’s risk position, this department is also a negotiating partner and advisor to the bank’s senior management.” The department is made up of a group of young and highly educated professionals who are extremely driven. Van Oort adds: “Our traineeships contribute a great deal to recruitment and internal dynamism.”

Forecasting

It is important that the bank is now capable of looking ahead to future developments with the use of forecasting tools. “The classic risk management function of monitoring, reporting and, if necessary, adjusting risk is possible using models and systems, but the world is changing fast – that is a huge challenge,” says Van Oort. “In addition, there is a mountain of rules and regulations that continue to descend on us and which has a great influence on the playing field. As a bank, you have to be more and more critical of the various balance sheet components. Partly because of the low interest rates, it depends on basis points and it is essential to look ahead using various scenarios to see what the impact on the balance sheet ratios and profit could be. The basic model Van Lanschot deployed has to be developed still further, last but not least because of the implementation of Basel III. Therefore, as of 2013, the development of a new forecasting tool was initiated which generates an integrated capital and liquidity forecast based on the expected balance sheet developments. “Zanders made an important contribution here. The good thing about Zanders is that they are real specialists with insight and a lot of practical know-how. But their pragmatic approach also appealed to me. It has resulted in a tool where we can detail the expected development of core ratios and where we can easily and quickly analyze the impact of mitigating measures on these ratios,” Van Oort says. “We are going to continue fine-tuning the good foundations we now have and by constantly carrying out back tests we can see if the forecasts tie in sufficiently. Where necessary, we will adapt the tool. After that, we will further integrate the tool with our ALM systems.”

A more complicated playing field

Van Lanschot is listed on the stock exchange but a large proportion of the shares belong to large financial institutions. “We are active in the capital markets and rating agencies look critically at how our ratios develop and how we cope with risk management. The playing field has become more complicated and the supervisory body also makes its presence felt. Shareholders are of course critical and look at our figures differently to how they did in the past.” The question is whether or not the rapid regulation changes have not overshot their goal in some areas. Van Oort adds: “You see that in the current lending climate: the required growth of capital buffers puts the brakes on possible lending. A new balance has to be found. Extra regulations were necessary, but the amount and complexity of these regulations results in higher costs. Banks’ buffers have increased enormously and also the quality of these buffers has never been so high. The AQR (Asset Quality Review) has confirmed that most banks are on track on this point. Last year it was clear that this was also true of Van Lanschot.” The rating agencies have recently reconfirmed Van Lanschot’s rating, and S&P has upgraded its ‘negative outlook’ to ‘stable’. This is a clear sign that Van Lanschot is on the right track. “It is still closely monitoring the execution of the strategy, in which profitability will be an important factor. Wealth management strategy implies that the interest company reduces in value but is compensated for by increased commissions. In the meantime, we have to maintain our healthy capital and liquidity position. Over the next few years, we will have to prove that the new strategy has been a success.”

Excellent

In the new banking territory, Van Lanschot, with its new strategy, is focusing more than ever on the customer. “Customer satisfaction is up there on top, as it is a very competitive business and for our bank it is essential for us to be an excellent service provider and offer customer value. The strategy we have set out provides a clear answer to how we see ourselves in the future. Within the field of risk management and ALM we are looking for professionals who feel at home in a specialist and dynamic private bank. The added value of our department is to be a sparring partner and advisor to the bank, all the while keeping in mind our penchant for discerning risk. That is a role which will develop along those lines. With all these changes we have a wonderful challenging time ahead of us.”