Dynamic Cash Flow Planning Requires Dynamic CFOs

I can’t resist: “Cash is King!” There, I said it (again)! Sure, everyone knows this, but with the economic clouds on the horizon looking uncertain, you might as well use this tired old cliche to start a conversation about money.

In recent months, more and more companies have experienced a “TMI” problem, namely, too much inventory. The problem stems from a combination of economic uncertainty, overly optimistic sales projections, fear of dissatisfied customers, a flight to “safety stock” resulting from supply chain disruption, and responses organizational precedents to persistently high inflation. Combine an inflationary environment with rising interest rates, reduced customer demand in a slowing economy, higher labor costs in a tightening market, and lags between remaining days of sale and the way the company manages its accounts payable, it’s no wonder that operating margins and cash are squeezed and conversations about liquidity are becoming more important. The question is: what can the CFO do to deal with the impact of these issues on cash flow?

These developments underscore the need for a more dynamic approach to cash flow management, an effort that CFOs must orchestrate across a wide range of organizational stakeholders, internal and external data sources, information and advanced technological tools.

As I noted earlier this year, many companies have chosen to pass higher manufacturing, logistics, and talent costs onto customers by raising prices. This strategy works well until it doesn’t, and many customers have reached this breaking point as they delay and/or scale back their buying activities.

CFOs are responding to demand-side challenges by making cash flow management, which encompasses planning and forecasting, more sensitive to external and internal factors. This requires understanding the causes and risks of ineffective demand planning as well as knowledge of what enables successful cash flow planning.

In response to the disruptions and shortcomings that predated the global pandemic, many businesses and financial groups have invested significant time, thought and effort into revamping outdated approaches to supply chain risk management. Ongoing economic volatility and uncertainty necessitate similar revisions on the demand side, as higher prices and rising interest rates affect purchasing behavior, pose credit risks for customers and increase the cost of capital, while giving rise to new implications of debt and obstacles to the planning of capital expenditures and strategic investments.

Dynamic cash flow management provides finance groups with deeper and more timely insights into trends and factors affecting cash flow. This visibility helps CFOs ensure that the company’s business partners expand their scope beyond the income statement and capital planning to manage cash flow in a way that strengthens organizational resilience in a context of uncertainty. These cash flow planning approaches include:

  • Working capital analysis: This insight goes beyond traditional DSO, DPO, and DIO analysis to identify trends affecting receivables, payables, and inventory that help generate actionable insights to improve working capital and cash conversion. Financial groups can calculate the Collection Effectiveness Index (CEI) to assess opportunities to improve customer collections. Analysis of the percentage of accounts at risk provides additional visibility into receivables performance drivers as well as customer mix, which should aid in credit risk management. Analyzing discounts taken versus discounts offered can allow the business to take advantage of prepayment discounts or provide additional context related to missed opportunities.
  • Scenario-based planning: By using just a few key variables related to the macroeconomic environment (e.g. interest rates) and firm-specific factors (e.g. fluctuations in customer demand), financial groups can mitigate financial risks and optimize cash management. Effective scenario planning identifies linkages to defined outcomes, such as seeking or reducing external funding or implementing cost reduction initiatives that affect fixed or variable costs. Analyzing and comparing different cash flow scenarios helps CFOs and business leaders make more informed investment, financial, and operational decisions. Note, according to my company latest global survey of CFOs and CFOsone in three organizations are refining and/or increasing scenario planning to address concerns arising from inflationary market trends.
  • Resistance tests: Executing what-if scenarios sheds light on best/worst prospects while allowing organizations to quickly adapt to changing market conditions. CFOs typically deploy a scenario-based approach to testing the impact of various economic assumptions on the business or on an investment portfolio. Starting with a baseline forecast for the most likely outcome, financial groups run multiple simulations for plausible and extreme alternative scenarios to develop a probability distribution of economic outcomes. These analyzes can also support capital planning by identifying potential changes in the cost of capital and shedding light on investments that should be reduced based on a specified increase in interest rates.

Major financial groups also incorporate product profitability data, inflation-adjusted information, debt and equity strategies, currency exposures (and mitigation strategies), and venue planning strategies. work, among other economic, supply chain and ESG considerations, in cash flow planning. Such efforts yield more actionable results. For example, product profitability analyzes can lead to product SKU rationalization that frees up inventory, reduces costs, and can even identify completely unprofitable customer relationships.

A dynamic cash flow management capability requires new collaborations, new supporting technologies and, often, a new mindset. Business partners and other financial customers tend to operate in a P&L mindset. From a cash flow perspective, excess inventory and the business decisions that caused the excess likely have no associated cost. A cash flow mindset helps business partners understand how their decisions ultimately affect the funding of operations and even the fate of strategic investments.

As CFOs expand and deepen their cash flow management-related collaborations with more stakeholders, they must demand access to more data sources across the organization. Finance groups should improve their communication with sales and marketing and demand planning groups that have insight into changing customer needs. Treasury groups should keep CFOs informed of their work with banking partners regarding changes to short-term and long-term strategies to manage cash, investments, debt, and currency risks. Finance and treasury must also work closely together to monitor debt metrics and debt covenant calculations, as well as understand the cash flow impacts of planned capital projects and strategic initiatives. Finance group collaboration with data analytics teams and IT can help ensure that the right tools and information are available to deploy new cash flow planning models.

The annual planning and budgeting exercises currently underway in many companies provide CFOs with a timely opportunity. They must advocate for dynamic cash flow management while enlisting business partners in the finance group’s ongoing quest to access and analyze more data that is beyond the CFO’s direct control. By convincingly demonstrating the importance of a cash flow mindset, CFOs will avoid having too little information to prevent deteriorating margins, emerging liquidity issues and related challenges. to hamper the company’s performance in the months to come.

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