Taking a fresh look at cash management

How you manage your cash flow can have a big multiplier effect on your company valuation but most finance tools are not optimizing for that, Jeff Epstein, former CFO of software giant Oracle, says.

“If you can improve your cash flow by $1 million, fundamentally, it means you’re really saving at least $3 million and probably $10 million in terms of valuation of the company,” says Epstein, now operating partner with Bessemer Venture Partners. “Incredible leverage.”

Despite its importance, cash flow often gets short shrift in finance systems. 

“Most company tools are focused on GAAP accounting and not on cash flow,” he said.  “And yet when you ask companies what they’re thinking about in terms of capital structure, it’s, ‘Well, when do I need to raise my next round of cash if I’m losing money and l’m backed by venture capital or I’m private equity backed?'”

Even with public companies, which tend to focus on earnings rather than cash flow, investors can appreciate the impact of cash flow improvements on company fortunes, he says. 

“The sophisticated public company investor also thinks in terms of an internal rate of return (IRR) and how to get a good cash-on-cash return,” he says. “In addition to all the normal systems you have, if you can also have a system of processes and tools to focus on cash flow, and you can save $3 or $10 for every $1 you save in cash flow, that’s really important.”

Two years of runway

Getting a handle on cash was particularly important last year when the coronavirus hit as companies looked to their CFOs to come up with at least two years of runway to help them survive the uncertainty. 

“For organizations that didn’t have a centralized way to look at that information, it became a mad scramble,” says Gopal Ramanathan, senior finance director at Icertis, a contract management software company. “They had to piece together different contracts, different types of information.”

Tracking that information is easier now that companies no longer rely solely on spreadsheets, but how you set up your tools is crucial, says Ramanathan. 

After he brought in a software system to help his team improve collections at the outset of the pandemic, he learned he could get more value by using it to improve coordination between collections, sales and finance.

“We used a feature to tag a lot of qualitative information that doesn’t typically associate purely with collections,” he says. “That helped sales reps understand what was happening with their customers.”

One tag might indicate that the collections team had already made three calls to a customer. By giving sales reps access to that kind of information, they could let collections know of any sensitivities that would make an additional collections call unproductive.

“That gave them the ability to tag their customers and let collections know sales reps do not want you to reach out to the customer,” he says. 

Prior to having the new tool, teams were relying on customer relationship management systems, which wasn’t optimal from a cash management perspective.

“CRM is there to help teams attract deals and successfully deliver on them,” he says. “But a finance team that’s interested in cash flow forecasting has a different mandate, so having a dedicated tool that also gives them the ability to pass that relevant information to the sales rep really worked, because even from an integration standpoint, we were able to pull information from Salesforce, provide that real-time to collectors and they in return took that information and sent it back to our sales teams.”

Slow incoming cash

There are many reasons customers aren’t paying their bills or are systematically paying them late, which throws off forecasts and reduces cash to the company, and you need upfront visibility into these reasons if you’re going to fix the problems, Epstein says. 

“It could be that the customer signed up and never had any money,” he says. “Your sales people are wasting their time and sales commissions signing up customers who would have never paid. It could be they could pay you at first but then they ran into trouble.”

Other companies actually build in late payments because of the interplay between when their revenue comes in and when their vendor bills come due.

“They say they’re going to pay you in 30 days but, if you’re an advertising agency and you fund your business on the float between when you get paid by your clients and when you pay your vendors, you’re intentionally paying slowly because that’s how you built your business,” he says. 

In many cases, late payments simply stem from bad management.

“They could just be disorganized,” he says. “They want to pay timely but they can’t find the bill or they sent the bill to the wrong place.”

The problem could be on your side as well, he said, if you have bad information on your customer or they no longer think they’re getting value from you. 

“You could have a product problem,” he says. “They want you to fix the problem and this is one way of getting your attention, or they don’t like the product anymore and plan on canceling anyway.”

Regardless of the reason, the cash management system should be able to flag these problems upfront so the finance team can intervene with solutions, he says.  

Leadership visibility

More broadly, cash management involves internal decision-making as well; company leadership, including business function heads, must know the impact their actions have on cash flow if the CFO hopes to manage that impact better. And that starts with visibility. 

“Cash flow in a sense tends to be looked at as a finance metric,” says Ramanathan. “A big goal of every finance leader is to make sure when they speak the language of cash, they also make sure the business leaders can follow that and see how the decisions they’re making impact those outcomes.”

“[The CFO] can make sure we know all of the things coming into and out of the business and the best way to manage through that,” says Hope Cochran, former CFO of King, the maker of the Candy Crush game app. “That’s an important role that gets lost a little bit. People think we’re just there to take in what’s happening and record it and produce a report. There’s another step: the CFO translates that report, goals and the actions to get there.”

Since the start of the pandemic, cash flow forecasting has gone from being challenging to nearly impossible.  

Historical cash flow trends have gone out the window, and for most companies, the dramatic change in revenues and costs couldn’t be imagined. Many retailers, for example, moved into virtually unchartered ecommerce territory. Even the likes of Amazon and Walmart couldn’t anticipate the rapid change in buying patterns and the potential growth in sales that would lie ahead. By the end of 2020, online shopping in the United States increased by 44%, to $861.02 billion, the highest annual ecommerce growth in two decades. Online sales now account for 21.3% of total retail sales. 

In one year, Amazon’s online retail sales grew 37.6% from $280.52 billion in 2019 to $386.06 billion in 2020. This compares to a year-over-year increase between 2018 and 2019 of 20%. 

Walmart also showed an unexpected revenue boom as shoppers moved from their bricks and mortar stores to online channels. In 2019, the retail giant’s sales grew by 1.8% over 2018, and in 2020, by 6.7%.

Similarly, companies operating in the healthcare market couldn’t foresee the change in cash flow that was about to come. For Tente Casters North America, the U.S. division of a manufacturing conglomerate headquartered in Germany, medical supply sales skyrocketed,  operating costs were changing in real time, and input pricing for materials was uncertain. In just four weeks over March 2020, order intake in their medical products vertical increased by an 252% — an amount they couldn’t have predicted.  

“We had to rearrange production lines to focus on medical products to keep up with demand, add head count and reach out to different sources of supply for component parts, even if it meant at a higher cost, CFO Pierce Kohls told CFO Dive. “Forecasts of inflows and outflows would change by the month.” 

In other companies, like Midwest Industrial Supply, sudden swings in commodity and input prices during COVID would test even their most sophisticated forecasting models to the max.  

Midwest is a privately owned U.S.-based company providing de-icing, erosion and soil stabilization services to mining, construction, mass transit and other heavy industries. At the best of times, forecasting revenues beyond a three-month horizon was a challenge. “To a large degree, demand for our services depends on things like commodity prices and raw-materials demand,” CFO Mark Schoolcraft said. 

Midwest uses different forecasting methods for each business unit, combining historical data and linear regression models with predictive analytics. However, “the forecasting challenge with COVID,” Schoolcraft says, “is that it comes with effects that history won't tell us.”

Missing the mark

All this volatility is the enemy of accurate cash flow forecasting and effectively managing working capital, says Dr. Howard Johnson, managing director at Duff & Phelps, a Kroll business. “For example, if you get your sales and expected receivables wrong, this impacts your cash conversion cycle, which has a lot of secondary implications,” he said. “During COVID, customers [haven’t been] paying as quickly because they’re experiencing their own cash flow problems. So, we’ve seen a lot of cases where working capital has expanded at a faster rate than revenues, and this causes a cash flow crunch, particularly for growing businesses.”  

In an example Johnson provided, if sales are escalating at 20%, but because customers are taking longer to pay, receivables might be expanding at 30%, which will drain cash. As a result, “companies have to be very proactive with their lending institutions in order to ensure they have adequate debt capacity to facilitate their rolling working capital requirements.”

Inaccurate cash flow forecasts aren’t just an operational problem; they can hinder the sale of the business. 

Valuation trouble

If companies aren’t getting the cash flow forecast right, their ability to put a value on the company if they’re preparing to sell the business is made more difficult, Johnson says. “If budgets and forecasts are not achieved because of volatility, it has a downward influence on valuations because credibility is shot,” he says. 

So, how can CFOs improve their cash flow forecasts under high volatility?  

“The first rule about forecasts is that, you know they're going to be wrong,” says Johnson. But a properly done forecast, which includes meaningful sensitivity analyses, can go a long way to getting closer to the mark.  

“It’s well worth the time and effort for CFOs to develop a very comprehensive cash flow model for their organizations,” he says. “I think it's important to forecast cash flows by estimated revenue by product, by customer, by currency, and by breaking down operating costs between fixed and variable and other categories. If there are certain variables, like key input prices that could fluctuate dramatically, having a proper sensitivity analysis can help.”

Even though the forecast might not be perfect, it helps the CFO with the company’s lending partners. 

The other benefit of that approach is that the CFO can extract some highlights and present them to his or her colleagues and that can be a very effective tool for getting everyone thinking about the importance of cash flow monitoring. 

“At the end of the day, adding more detail to the cash flow forecast can help executives manage the type of volatility we’ve seen over the past two years and makes the CFOs job a bit easier,” Johnson says. 

Nearly three out of four financial executives say pandemic disruptions underscored the imperative to achieve real-time tracking of cash inflow and outflow, yet only 12% of them currently are automating their accounts receivable and accounts payable, Forrester found in a survey.

“The majority of AR and AP departments tend to operate separately within finance organizations, citing a lack of resources and expertise for automating those processes,” according to Matt Clark, chief operating officer at Corcentric, which commissioned the Forrester survey. Companies that want to reduce costs, increase profits and improve the customer experience must make optimizing AR and AP systems a priority, he said.

Survey respondents said “holistic” cash forecasting would prompt smarter decision-making (97%), streamline payments for all users (88%) and increase business agility (83%), Forrester said. At the same time, respondents believe that without a complete, real-time view of their cash position they face greater risk of fraud (52%), and are less able to adapt to disruption (45%) and identify funding to support stakeholders’ top priorities (48%). 

The global onset of COVID-19 nearly two years ago plunged the U.S. economy into its sharpest recession ever and compelled companies to hoard and more closely track cash.

The Federal Reserve and Congress reversed the cash crunch and averted a prolonged downturn by swiftly enacting record monetary and fiscal stimulus which has only begun to fade in recent months.

Despite lessons from the collapse in liquidity, nine out of 10 survey respondents are not automating their AP and AR processes, Forrester said, noting that the two functions remain siloed.

“Most companies are interested in enabling a real-time, complete view of their cash position, but few can actually do so today,” Forrester said. “Holistic cash forecasting can not only help with cash management but also contribute to better risk management, improved fraud management and more effective financial planning.”

Although 82% of financial executives want to achieve holistic cash forecasting, only 5% have the partners and/or systems in place to do so, Forrester found in its survey in July of 663 CFOs and other C-level executives, as well as directors and vice presidents, at companies in France, the U.K. and U.S. The companies’ annual revenue ranges from $750 million to more than $5 billion.

More than half of companies (57%) struggle to upgrade payment processes to meet users’ needs, Forrester said. Seven out of 10 financial executives say their cash flow systems provide only partial insight into their companies’ financial position.

“To gain the benefits of holistic cash forecasting, CFOs need to be the leaders in driving the process automation and the data integration across and between” AP and AR, Forrester said.

“The key to holistic cash forecasting is to capture data on outgoing cash payment obligations in approved AP invoices and on incoming cash receipts based on customer approval of submitted AR invoices,” Forrester said. “AP and AR invoice automation systems are the best sources of this advanced data.”

When WeWork was preparing for a bond issue in 2018, underwriters were raising concerns over its leverage. The company’s response wasn’t to reduce leverage by adding equity or lowering debt but by adjusting EBITDA until it got the ratio it wanted.

“We all know how that story ended,” Andrew Holmes, a Moody’s Analytics director, said in a Moody's Analytics webcast.

By turning its $193 million loss in earnings before interest, taxes, depreciation and amortization (EBITDA) in 2017 into a positive $233 million in what it called community-adjusted EBITDA, it erased its leverage problem without having to make any changes to its planned bond offering. 

“People didn't believe in community-adjusted EBITDA,” he said, but that didn’t stop them from investing in the company.

It was one instance in which the company adjusted EBITDA to meet its short-term needs while masking a longer-term leverage problem that came to a head in 2019, when it had to pull its IPO because of valuation concerns. 

Extreme case

Holmes called the WeWork saga a cautionary tale of misusing EBITDA, a metric that can provide a good measure of company performance over time and that’s useful for setting valuations, but is too often seen as a proxy for cash flow or, in some cases, profitability. 

It’s neither of those things, which is why EBITDA often increases while cash and profits decrease, and vice versa, depending on market conditions.  

But because so many people use it, it’s important for accounting professionals to calculate it thoughtfully and consistently. “You want to be clear what it is,” Holmes said.

Non-GAAP measure

Accounting organizations are unlikely to treat EBITDA and its adjustments in a standardized way anytime soon.

That’s because the metric, created by investment bankers to show growth promise, isn’t recognized under Generally Accepted Accounting Standards (GAAP) in the U.S. or International Financial Reporting Standards (IFRS) elsewhere. 

Given the lack of standardization, organizations should do their own EBITDA calculation if they’re trying to raise credit capital and the lender looks at the measure in calculating leverage.

“If you think someone’s going to calculate your EBITDA, you should do your own” and offer that number, he said.  

In WeWork’s case, it changed a negative to a positive by first calculating adjusted EBITDA by making relatively common adjustments, including to depreciation and amortization. WeWork then calculated what it called Adjusted EBITDA Before Growth Investments by adding back in costs that are typically excluded, such as those for sales and marketing and new market development.

It justified the adjustments on the grounds that, once new office buildings came on line, they would generate revenue without the company having to pay those expenses anew.  

“So, add those back in,” Holmes said.  

It then made a subsequent adjustment — its Community Adjusted EBITDA — by adding back in general and administrative (G&A) expenses. It was “a new animal, never before seen in the wild,” he said.

Cash flow differences

Free cash flow (FCF) is another widely varying metric that lacks standardization but, like EBITDA, lenders commonly use it in underwriting loans. For that reason, if you’re seeking to raise credit capital from a lender that calculates payments based on it, you want to do your own calculation so you know what you’re facing.

“Look at that and not EBITDA,” he said.  

In general, FCF is the cash available to service lenders and shareholders and do things like acquisitions after the company has incurred expenditures that are effectively mandatory.

You can think of it as adjusted EBITDA but without interest, working capital changes, capital expenses, and some other line items, he said. 

Some organizations also exclude dividends, which Moody’s recommends.  

That’s because companies typically treat dividends, though discretionary, as mandatory. 

“Kellogg's has paid a regular and rising dividend for decades,” he said. “If the chief executive of Kellogg's were to cut the dividend, would that impact his job prospects? You bet it would. Has he borrowed money in the past to pay his dividends? Yes, he has.”

Private companies also treat dividends as mandatory, Holmes said. 

EBITDA vs. FCF

Although EBITDA and FCF measure very different things and can move in opposite directions depending on companies' responses to changing market conditions, accounting teams should be prepared to do their own calculations when trying to raise credit capital.

“If you expect it to be repaid by cash flow, know how it's calculated,” he said. “Know how cash flow varies from sector to sector, and through the cycle.” 

Bottom line, both EBITDA and FCF, despite their lack of standardization, are useful measures, he said, but be thoughtful in using them.

Cash flow, generally defined as the net amount of cash transferred in and out of a business, is king — especially when the economy is as uncertain as it is today.

"It all starts with the cash flow statement," Alonso Ramos, CFO of artificial casings manufacturer Viscofan USA, said. "I recommend to update cash flow on a monthly basis," as it is critical for tracking revenues and customers. "It should be as comphrehensive as necessary for the size of the business include all the money coming and coming out for the month."  

Any company's ability to create shareholder value is determined by its ability to generate positive cash flow, making it a vital metric across industries. But staying on top of operating, investing and financing cash flow is not always easy or intuitive. It's incumbent upon CFOs to have a keen awareness of their company's cash flow, particularly when all other aspects of the business become less predictable.

The three KPIs factoring into Ramos' cash flow calculations are accounts receivable/days outstanding, stock coverage and days payable outstanding. "You don't want to be delayed on payments," Ramos said. "Especially now."

"It's very important to manage the KPIs that will help identify opportunities to improve cash flow," he said. "[The KPIs] start with accounts receivables days sales outstanding, that represents how fast the money is recovered from the customer," but also is necessary to perform sensitivity analysis on the metrics, "prioritizing the top customers that represent a larger percentage of sales," Ramos said. "If a customer represents 80% of our sales, and we want to calculate days outstanding, that number will be very important." 

Ramos has established his cash flow predictions through the end of 2020 and all the way to the end of 2021. He typically plans 12 to 15 months ahead. The actual amount of forecasting doesn't matter, he said; it's the diligence in planning that's key. And he sub-divides payments from Viscofan's major providers into groups based on operations, administration, insurance and taxes.

Turning to the treasurer

"In March and April, a lot of companies needed to shore up their balance sheet in order to survive," Tom Hunt, director of treasury services for the Association for Financial Professionals (AFP), said. "The focus really became more on the balance sheet than on the income statement."

In his practice, Hunt sees treasurers' (and other finance leaders') top KPIs as committed and uncommitted credit lines. To build a liquidity buffer against events such as the pandemic, these executives have opted to tap into bank syndication and holding cash.

"Assessing which credit lines are available, with which banks you have relationships, and where you can draw upon excess credit is really paramount when you don't know what's going to happen," Hunt said. "Cash is a company's lifeblood, so being able to meet short-term needs and making payroll and making payments to vendors is vital."

In dire situations, companies tend to look inwards to see where they can make more cash available, Hunt said. "And what that's amounted to, for a lot of treasury professionals, is digitization of payments — trying to convince vendors to accept an ACH or electronic payment instead of check. That impacts cash flow too."

Hunt looks at two forms of cash flow. The first, operating cash, Hunt defines as cash needed in the next 30 days. The second is a rolling liquidity forecast, which he looks at to meet payroll and AP.

"A lot of those payments are to utilities and tax authorities: things you don't want to have signaling to the industry as being delayed or uncertainty-causing," he said. "You want to maintain operating cash as much as you can."

Treasury and FP&A professionals are doing ample multi-faceted liquidity planning amid the pandemic, Hunt said. Instead of three-way scenario analysis, they're doing 14-way.

"Reporting what used to be weekly to the CFO is now done on a daily basis or even once an hour," he said. "They'll report on what credit is available to shore up the balance sheet, what cash balance is going in or coming out versus what's been forecasted, how much cash is on hand in the event we can't access capital markets."

A focus on cash origination is also key, he said. "Many [AFP] members are talking to their banking partners and looking at a lot of digitization efforts, looking for ways of being more streamlined and efficient, with a goal of making sure cash flow is of utmost importance."

How often a company should look at its cash flow statement depends on a handful of factors, he said. "Look at net investors and net debt positions. Each position looks at cash flow in a different lens, and it varies by industry; a retailer looks at it with much different seasonal flows that a factory person."

Large, publicly held companies tend to report much more often, probably on a daily basis, he said.

Reporting at that frequency can put a big burden on Treasury teams, but today's uncertainty is unusual. "During times of stress, where the company is working remotely, sometimes demand exceeds what it's capable of," Hunt said. "Treasury will always rise to the challenge and be in the liquidity game, but recognizing there's always room for improvement; certainly where treasury teams are small and tasked with doing more with less."

Growth mode needs cash flow

Peter Habelitz is CFO of Netherlands-based Cycas Hospitality, which is near-doubling its open hotel portfolio within the next six months. Amid the growth, he said, the adage "cash is king" has become even more true.

"In times of crisis, cash becomes exponentially more important," he said. "And it has made having a sound cash management practice the single most important factor."

Securing adequate financing and ensuring available funds are employed efficiently is imperative to Cycas' success, and is significantly more important than the usual P&L metrics or balance sheet KPIs, he said.

"My EBIT [earnings before interest and taxes] can look all rosy, but if I don't have enough cash to perform on my financial commitments on future investments, the growth plan will derail," Habelitz said. "Especially off balance sheet items and cash traps, like collateralized guarantees, which can easily make your cash balance look healthy, when, in reality, there's a large cash outflow you weren't aware of."

Habelitz and his team spend significant time developing proprietary tools to keep on top of its cash flow, both on a consolidated corporate level as well as on an individual hotel level. These tools include a mid-term cash flow model that maps out its cash-in and cash-out flows on a monthly basis over a rolling five-year period. Meanwhile, a second model calculates working capital needs for each project over the next five years, as well on a monthly basis.

With these tools in place, Cycas forecasts its operational business' full cash requirements, as well as for upcoming projects, on a monthly consolidated basis against actual cash flows, while incorporating any updates.

"Doing this ensures we can identify any upcoming cash needs and effectively move funds around as needed," Habelitz said. " We have developed a deep expertise in cash flow control and that has been instilled into all parts of our organization."

Company-specific cash flow strategies

Unlike other industries, like retail or manufacturing, hospitality has a naturally positive working capital cycle, Habelitz said.

"Receivables and inventories are minimal, and, as such, we don't need to invest significant energy on optimizing working capital and maximizing cash flows out of it," he said. "However, long-term financial commitments, such as lease contracts, drive our business, and with that, our landlords require deposits and guarantees for security."

Cycas strategically optimizes its balance between cash deposits and use of bank guarantees and insurance, and constantly looks to optimize other factors, including timing of rent payments.

"Our tactics focus on individual projects and ensuring cash flows are optimally structured and lead to an ideal level of cash from a consolidated perspective at any given point in time," he said. "We look to deploy cash in periods when there's excess available, and retrieve the cash back into the business during periods of increased cash-out flows."

In times of negative interest, Habelitz doesn't want too much cash sitting idle in a bank account, costing Cycas money.

"Having a fitting set of cash flow focused KPIs in your weekly or monthly reporting is definitely very important," he said. "It does very much depend on your business which KPIs those are."

When Habelitz worked for a manufacturing company, he managed and reviewed days sales outstanding and inventory turns on a daily basis, because they were the most difficult to influence and most complex to manage.

But for a business-to-consumer [B2C] company where most sales are paid directly with credit cards, for instance, days sales outstanding wouldn't be a meaningful KPI to track, he said.

At Cycas, classic working capital KPIs are less relevant.

"Since we have a range of different agreements with our banks, we do have cash-related covenants such as liquidity or interest cover ratios, which we monitor on a regular basis," he said. "But our main focus is on the deviations between the actual cash flow and our cash flow forecast." Understanding these deviations enables him to improve modeling and forecast accuracy, manage cash and initiate corrective actions.

Simultaneously, he includes any investment proposals in his cash flow model to evaluate the impact, as well as available funds within the next 24-36 months.

Cycas' strategy is aligned to cash flow measures, and all ROI assessments are based on cash flow metrics. This will change over time as it reaches different growth stages, Habelitz said, but cash flow will always be vital.

His team is developing a set of liquidity KPIs to monitor its secured vs. unsecured guarantees and commitments strategy. "This will allow us to easily monitor the potential cash risks and their coverage to ensure we are prepared in case an unsecured guarantee was to be called," he said.

Cash in crisis

"Cash is obviously important for every company, and especially in times of crisis," Habelitz said.

"To ensure your business is successful, it's vital to stay on top of your cash flow, use the right KPIs to monitor it and to consider the impact of any business decision on your cash flow," he said.

 

CFOs facing mounting wage pressures and rising wholesale prices can blunt the harm from high inflation by reviewing company assets and liabilities and unlocking cash. 

The CFO strategies for freeing up cash range from divesting underperforming assets and analyzing receivables and payables, to tightening up credit support and speeding returns from partnerships, McKinsey said in a report.

Financial executives usually focus on an income statement to reduce debt-to-equity ratios, boost profitability and improve resilience, McKinsey said. “Few companies give much thought to the assets and liabilities on a balance sheet that can unlock lucrative opportunities.”

CFOs this year have had to quickly adapt their companies to the biggest spike in prices in 30 years.

The consumer price index last month rose at a 6.2% annual rate, according to the Labor Department. The Federal Reserve’s preferred measure of price gains — the core personal consumption expenditures price index — rose 3.6% in September.

The producer price index for final demand, a measure of what suppliers charge businesses, soared 8.6% in October from the prior year, according to the Labor Department. That was a record jump in a series of data first published in 2010.

“Helped wanted” signs go unanswered, prompting CFOs to raise wages. The quits rate, or the number of workers who left their jobs as a percent of total employment, increased 3% in September, the highest rate in data going back to 2000, the Labor Department said Friday. There were 1.4 job openings for every unemployed worker. 

In response to the labor shortage, many businesses have increased compensation. The proportion of small businesses that raised pay last month hit a 48-year high, with a net 44% increasing compensation and a net 32% planning to do so in the next three months, the National Federation of Independent Business (NFIB) said last week.

CFOs can take some of the bite out of inflation, McKinsey said, by taking six steps to free up cash on their balance sheets:

1. Review receivables and payables

By finding process gaps in receivables and payables from the prior year, CFOs can shake loose cash for investment, debt reduction, dividends payments, and mergers and acquisitions, McKinsey said.

Slow invoicing, weak collections policies, early payments to vendors, inefficient payment processes and out-of-market terms can all slow the cash-conversion cycle and tie up cash, McKinsey said.

A thorough analysis “usually reveals process gaps, unfavorable and unnecessary terms with customers and vendors and other near-term opportunities to improve working capital,” McKinsey said.

2. Sell or ‘reimagine’ underperforming assets

By identifying returns — or losses — from property, plants, equipment and other long-term assets, a CFO can single out low-performing assets for sale or repurposing.

"Those assets can then be sold or re-purposed, improving results by freeing up cash through the deployment of assets to higher-value activities and delaying planned capital expenditures," McKinsey said.

3. Recover ‘trapped’ cash

Cash may sit dormant among joint venture partners or foreign subsidiaries that lack an operationally or tax-efficient way to deploy it. Dividends from partnerships may arrive only after a lag. A thorough review of the balance sheet can identify partners with outstanding payments.

Also, by streamlining global cash management, a CFO can reduce the number of urgent cash transfers in a year, McKinsey said.

For example, a telecommunications company found that half of the cash on its balance sheet was inaccessible because of local account restrictions. The company freed up cash and reduced its dependence on external funding by updating its bank account structures and global cash management practices.

4. Pursue smart credit support

CFOs that use cash collateral, letters of credit and surety bonds as credit support for commercial or regulatory purposes may end up misallocating liquidity, McKinsey said.

A CFO and treasurer, working with legal counsel, can often improve a company’s liquidity by confirming on a quarterly basis that all credit support is still necessary.

For support still needed, a CFO should identify the most capital-efficient way to do so. At some companies, this may mean replacing cash collateral with a letter of credit, or a letter of credit with a surety bond that does not require further collateral, McKinsey said.       

5. Find alternatives for funding pensions

CFOs at companies with significant defined-benefit obligations can improve their outlook through one or a mix of several options: liability-driven investing, changing existing defined-benefit plans, freezing the plan and converting it to a defined-contribution plan, or adopting a cash-balance plan.

For example, a large U.S. retailer eliminated several billion dollars of pension liability for 30,000 employees by transferring the liability to an annuity provider. The retirees saw no reduction in benefits, and the retailer avoided volatility and future funding requirements.

6. Reduce long-term liabilities

A CFO that reduces environmental and other long-term liabilities can build a pool of cash for investment in high-performing business ventures to distribute to shareholders. The assumptions underlying some environmental compliance may no longer be valid, or compliance may be handled more efficiently.

For example, a U.S. power company found during a review that its balance sheet failed to account for completed reclamation and remediation. It worked with regulators to revise its environmental liabilities and reduce the needed credit support. 

“Companies that schedule robust, regular reviews of their balance sheets can increase working capital and convert underperforming assets and capital-consuming liabilities into accessible cash,” McKinsey said. “Together, these changes can finance M&A, research and development, and capital expenditures; strengthen resilience; and increase distributions to shareholders.”