- Cash management is part of managing liquidity, using cash generated by business operations, cash surpluses retained in the business and short-term liquid investments. Day-to-day management of cash ensures payment obligations are met when they fall due;
- Manage supplier payments, receivables and inventories to optimise the investment in working capital; and
- Organise and manage borrowing facilities using cash-flow forecasts, building in planned/required new funding and maturing funding that must be repaid or refinanced.
Cash versus liquidity management
Cash and liquidity management includes a variety of tasks, including: daily cash management, cash concentration, cash forecasting, reconciliation (sometimes only of treasury transactions), in-house banking and cash reporting – all part of supporting the strategic and financial objectives of the organisation. The two terms are often used interchangeably, but technically speaking the following definitions apply:
Liquidity management is focused on ensuring that an organisation is able to meet its group-wide business liabilities as they fall due. Liquidity management involves managing the payments and receipts arising from business operations overlaid with any treasury-related activities (such as loan interest payments, settlement of currency deals, etc). To be effective, it will normally require engagement with finance, payments and receivables teams.
Cash management focuses on aggregating balances across the organisation to optimise liquidity to deliver the most cost-effective investment or borrowing of any surplus or deficit that arises.
Liquidity enables organisations to pay their obligations where and when they fall due, and to source additional funds to meet further obligations. Successful liquidity management therefore depends on having an insight into the business’s future cash generation or absorption – a cash forecast. Cash forecasts are fundamental to a liquidity strategy, with the treasurer often looking ahead over several time frames to manage liquidity.
Who is responsible for what?
- Corporate culture;
- Variability of business-generated cash inflows and outflows;
- Costs of local facilities;
- Local regulations;
- Risks associated with local banking counterparties; and
- Levels of expertise and size of local teams.
Central or decentralised structure?
In reviewing any investment strategy, it is important to identify and segment cash flows appropriately, irrespective of whether they are inflows or outflows. There are typically three:
Business cash flows
Depending on the type of business may be highly variable. Retail businesses are often affected by the seasons, festivals and the weather. Commercial property businesses will typically have a highly predictable revenue stream of monthly or quarterly rents.
Treasury cash flows
Treasury cash flows mainly comprise of interest payable or receivable on loans or deposits as well as dates when capital repayments are due. They may include both external interest as well as internal interest. In either case, material amounts will be highly predictable.
Depending on the level of corporate finance activity, sales or purchases of business may be rare or occur frequently. In either case, the specific timings of when payment is received or paid away may not be known until the last minute. In addition, it will often be known by only a few people.
In general, the treasurer will be involved in central fund raising and any corporate finance activities (such as disposals and acquisitions). Investment management activities therefore need to be undertaken in conjunction with other projects and activities that may be occurring. (For example, the raising of funds may result in a short-term surplus, which is intended to fund an acquisition. Depending on the timing of the acquisition, the funds may need to be specifically invested or included in general corporate liquidity management decisions.)
The more decentralised the cash and investment management activities, the greater the importance of a clear, comprehensive and definitive investment policy. Any flexibility will require careful monitoring and reporting considerations (including who will be producing the necessary reports) will need additional attention.
The first stage in the investment management process is to identify the circumstances in which the investment is being made; factors include the currency in which the funds are denominated (and whether FX transactions are permitted) and the time period for which the funds can be invested (and whether the company is comfortable with investing for that period), as well as the relative importance of security, liquidity and, if appropriate, yield as objectives. By doing this, the treasurer will be able to select an investment instrument to match the objectives and risk appetite for a particular set of conditions that is in line with the investment policy.
Typically, investing larger amounts for longer periods will generate the greatest yield. However, this needs to be balanced by operational requirements and uncertainties, which may result in higher cash requirements than normal. Optimising liquidity has three components:
- Concentrating cash balances across different currencies;
- Managing working capital to limit any leakage of operational liquidity; and
- Understanding the uncertainty of future cash flows.
Having identified the investment requirements, the next challenge is determining the liquidity structure. There are a number of instruments available for the treasurer and financial institutions to continue to innovate in response to customer requirements and market developments (such as 24/7 payments). However, for the benefit of this guide, we will look at the following investment buckets:
- Overnight: Operating cash, used to fund day-to-day needs, requires late-day/same-day liquidity;
- Short term: Reserve cash, used for such items as large capital expenditure, product investment and inventory build-up, does not require same-day liquidity (less than six months); and
- Medium term: Strategic cash, surplus cash that can accommodate relatively more limited liquidity, can be invested over a medium-term horizon.
Risk and opportunities vary across the categories, and it is therefore important for the treasurer to consider:
- Proportion of available cash that can be invested for more than 30 days;
- Yield difference between overnight and longer-term investments;
- Confidence in the forecast of net cash requirements over the short and medium term;
- Importance for investments to be accounted for as cash and/or cash equivalents;
- Effort required to invest for a longer time period than overnight; and
- All-in costs of the different options (including transaction and legal costs).
Where treasurers have significant liquidity, it may be material to separate the funds into different investment instruments with different maturities in order to increase the overall portfolio yield. On the flip side, where it concerns small balances, it may be more cost-effective to keep the funds with the main relationship/clearing bank or in a low-risk money market fund (MMF).
Market scale and scope
Investment instruments have different terms and conditions depending on the market in which they are issued. Typical factors, which will vary according to jurisdiction include:
- Interest: Interest payments calculations vary per currency. Some rates are calculated on a 360-day year basis and others use a 365-day year.
- Minimum investment period: Local banking regulations may prohibit the payment of interest on investments made for less than a minimum period.
- Maximum investment period: Some instruments may be subject to a maximum investment period, due to local securities regulations. For example, US commercial paper offered for sale to the public is limited to a maximum maturity of 270 days, otherwise it would be required to be registered with the US Securities and Exchange Commission.
- Tax liability: Liabilities vary per location. Specialist tax advice is necessary before making investment decisions.
- Investor eligibility: Some investors may be prevented from investing due to local restrictions. For example, in normal circumstances, US investors are prohibited from investing in European MMFs. Some countries, including Russia, place restrictions on access to local bank accounts.
Cash and cash equivalents
Auditors apply strict criteria in defining what can be considered as cash or cash equivalents, and it is critical that treasurers are confident on the accounting treatment before engaging in any new investment activity. IAS 7 specifies the following:
- Cash: Cash in hand and deposits on demand; and
- Cash equivalents: Highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value. Cash equivalents are held for the purpose of meeting short-term cash commitments rather than for investment or other purposes.
The definition of cash equivalents has three related components, which should be looked at together:
- Maturity (insignificant risk of change in value): An investment requires a ‘short maturity’ to meet the definition of cash equivalent. IAS 7 suggests this is a period of three months or less from the date of the acquisition of the investment. A longer maturity period exposes such instruments to fluctuations in capital value. The maturity period is measured from the date of acquisition, not the balance sheet date. The objective is such that the investments should be so near to cash that the only changes in value will be insignificant.
- Readily convertible to cash (readily convertible): The term ‘readily convertible’ implies that an investment must be convertible into cash without an undue period of notice and without incurring a significant penalty on withdrawal. Monies deposited in a bank account for an unspecified period, but which can only be withdrawn by advance notice, should be carefully evaluated to determine whether they meet the definition of cash and cash equivalents. Cancellation clauses, termination fees or usage restrictions might affect the redemption amount and create a more than insignificant change in value.
- Held for the purpose of meeting short-term cash commitments (short term, highly liquid): For a security to be regarded as cash equivalent, it should not only meet the definition in IAS 7, but also be used as a cash equivalent by the entity that holds it. That is, it should be ‘held for the purpose of meeting short-term cash commitments’. For example, an investing company might classify its short-term investments as investments rather than as cash equivalents.
Cash and cash equivalents provide a company with a valuable source of funding – especially during unplanned or unpredictable events and de-risk the financial risk of the business. As such, lenders, banks, investors and rating agencies all pay particular attention to this number. If a company invests for the medium term (for example, six or nine months), the external auditors may feel this does not qualify as cash or cash equivalents. They may remove it from current assets and it may affect covenant and key reporting ratios. The same may apply for any structured investment product. As a result, it is important to consider the accounting treatment whenever considering an investment decision.
A short-term investment is a highly liquid financial asset, meaning it can be easily converted to cash. Short-term investments are commonly called ‘marketable securities’ or ‘temporary investments’. Most are converted to cash or sold within 12 months of the investment being made. The aim of a short-term investment is to generate additional returns on a company’s cash balances, while preserving capital.
Where investments are held for resale, these will be shown as current assets. This heading may also include cash on deposit, with a maturity of less than one year for investment purposes.
Cash held as part of a portfolio of fixed-asset investments should be presented as part of fixed-asset investments. Cash will only be included in current asset investments if the organisation does not intend to hold the cash as part of its ongoing investment activities for more than one year from the year end, ie the business intends to withdraw the cash from the investment portfolio rather than reinvest it. The notes to the accounts should typically provide an analysis of current asset investments between:
- Cash equivalents on deposit;
- Investment properties held for sale;
- Investment in group undertakings held for sale;
- Listed investments; and
- Other investments.
Broadly speaking, trapped cash describes all cash that is not available for a corporate’s daily cash cycle, which due to regulatory restrictions on outgoing financial flows (in certain markets) is not accessible. These restrictions obstruct total or partial repatriation of the cash, requiring significant effort on behalf of the treasurer to access.
Given the renewed importance of available liquidity, treasurers continue to look for techniques to reduce the amount of trapped cash, not only for liquidity management purposes, but often to reduce currency and sovereign risk.
A full, in-depth review of how to handle, avoid and cope with trapped cash is available to read here on the Hub.
The rapid development of technology continues to provide treasurers with access to more granular information on cash flows and cash positions. Common data definitions and globally mandated standards will help to consolidate cash management and payment transaction for increased efficiency and transparency. Treasurers can increasingly see real-time transaction information for bank accounts located around the world and be able to drill down into individual transactions. Moreover, treasurers can use an expanding range of technology solutions to:
- View information from different sources;
- Consolidate the data to a single position shown on a single platform;
- Improve data consistency, integrity and reliability in terms of the cash position and liquidity forecast as a consequence of the harmonised infrastructure and business processes;
- Improve internal controls that are consistent across the organisation and compliant with local/external regulations; and
- Increase efficiency and transparency along the entire financial supply chain.
Key drivers for technology developments
1. Regulation: Open Banking initiatives (for example, in the EU and in Brazil) and the creation of new regulators (such as the UK’s Payment Systems Regulator) has enabled the opening up of core high-value payment infrastructures, such as TARGET2 for euros and CHAPS for sterling as well as introducing new payment rails and solutions (for example, Pix in Brazil). This, in turn, has encouraged new and existing technology vendors to innovate as they compete with each other for new and existing customers and applications.
2. Real time: Payments that previously could only be processed during specific working hours and days are increasingly capable of being processed in real time and on a 24/7 basis. This provides more flexibility to the treasurer of when to schedule a payment (as they will have greater visibility of intraday activity), but will also make the work of the treasurer more complex, as payments could potentially be received at any time of day or night.
3. Growing use of application programming interfaces (APIs) offering treasurers a range of tools and resources for viewing different balances and aggregating them (by currency or by entity).
Tools to aggregate balances from a range of banks across a number of different countries is not new. However, the costs of collecting the data and the investments in systems to enable the balances to be aggregated can sometimes be disproportionate to the value provided and the action that a treasurer could take. The application of APIs and open banking is opening new, more cost-effective ways of achieving this.
New data-visualisation software, such as Tableau, Power BI and QlikView, provide the treasurer with powerful tools to customise cash visibility dashboards. In combination with APIs, treasurers are able to configure what is reported on, how frequently the data is updated (including in real time) and how the information is presented. Senior management can be given access to their own dashboards, which can be refreshed at their own choosing.