Cash Management and Liquidity Planning: An Infographic
Treasury management processes are complex. Which means my favorite analogy from a treasury expert, to simplify the topic, was his comparison of treasury capabilities with the way we all manage our own finances. When we want to make a minor purchase, we can look at what we currently have in our bank accounts. When we want to make major purchase – say a car or a home – we need to go beyond what is currently in our accounts. We need to look into the future, including our expected income over time from salaries and investments, and variable income which may or may not be certain, such as commissions (and hopefully everyone understands that the expectation of winning the lottery is far from certain!). And we need to compare that income to current and expected outlays, be it day-to-day expenses, existing loans, potential college tuition payments, and the need to invest in our own futures, including retirement and health care.
The order of magnitude and the complexity is, of course, much greater when we talk about corporations. But the concepts are very similar.
Treasury Planning Horizons
The amount of information required for the treasury function depends on the time horizon involved, as well as how quickly they may need access to the financial resources of the company. For example:
- Short term:
- Calculating working capital (current assets minus current liabilities) provides the basic information of cash that is available for day-to-day operations and to cover short-term debt. The timeframe of “current” is typically recognized to be one year, so it includes assets that can be converted to cash in that timeframe, as well as liabilities due within that one year.
- Cash management involves managing current and expected cash flow. On the inflow side, this includes the current and expected receivables from customers, potentially expediting the receipt of payments though payment terms. On the outflow side, this involves as current and planned payables to suppliers, paying just early enough to take advantage of discounts. The available cash is often used for short-term investments.
- Medium and long-term: Liquidity management looks at available cash, and the ability to cover debts, by including a measure of how quickly assets can be converted to cash, using various ratios. For the medium term, it is important to note that some assets cannot be converted into cash quickly, such as major capital investments such as buildings. The longer the time horizon, the more such major assets and liabilities must be factored into the analysis of the solvency of the company.
Risk factors must also be included. Especially for global organizations, there may be currency risk as exchange rates fluctuate. The return rate of investments, interest rates, and hedges may vary over time, as they are affected by external market conditions.
Before and After SAP S/4HANA Finance
Let’s look at an example of the progression of the processes needed for cash and liquidity management with an example. On the left, the information needed for both short-term and long-term calculations and decisions must be gathered from disparate systems, resulting in delays and outdated information. The information is consolidated manually, and any off-line models built in spreadsheets remain fairly static, and lack the capability to provide forward-looking analysis.
Alternately, on the right, the organization that has implemented SAP S/4HANA Finance. All the information is in one place, meaning that there is no delay in beginning the analysis of the cash position of the company. In addition, with built-in planning and predictive capabilities, the treasury team is able to build models to evaluate what-if scenarios, and present the summarized results of various scenarios through a dashboard, which also allows drill-down to the lowest level of detail when additional questions come up from executives.
As you can see, SAP S/4HANA Finance enables James to skip the manual consolidation processes, so he can immediately see both the current cash position as well as projected cash flow and liquidity, whereas Sean spends the majority of his time tracking down and consolidating the data that he needs. Ultimately, Sean does not have the bandwidth to thoroughly evaluate various investment options. James, on the other hand, was not only able to address mid-term liquidity issues to cover short-term debt, but was also able to include external market conditions and risk factors in his predictive liquidity model to determine the best investment strategy to fund the growth of his organization.
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