The fightback of stressed cash forecasting in a turbulent world
October 21, 2020
Global turbulence and more than six months of uncertainty has brought cash forecasting and liquidity monitoring into sharp focus. It has also increased the importance of effective stressed cash forecasting to better understand and communicate the related down-side liquidity risk of certain key binary events.
There appears to be a general consensus that this challenging environment will continue for a while, and in a number of sectors the worst is probably yet to come. So in my view, it is not too late for the treasurer to strengthen current practices or introduce these tools.
However, there are three key issues to be addressed.
The first, before doing anything else, is to confirm what is important to your business as too many are missing important elements in their internal monitoring and reporting. I suggest this manifests itself not only in terms of identifying any KPIs that suggest looming liquidity shortages - such as cash burn rates, headroom, covenant compliance - but also, more positively, in aiding identification of any investable free cash, allowing advantage to be taken of immediate opportunities.
A second major challenge is that some treasurers and their teams have found they aren’t currently able to provide the enhanced level of information demanded of them. This is particularly pressing for those companies experiencing a liquidity-constrained environment for the first time. They may never have prepared a cash flow forecast, or have limited resources already placed under strain by other demands driven by the current situation.
Thirdly, perhaps most importantly, is a change in mindset. A stressed forecast is only as good as the scenarios it is designed to model. While we are in a strange operating environment, sticking to historic scenarios is unlikely to provide the relevant, insightful data needed by decision-makers. In addition, binary events such as counterparty defaults, have meant there is a wider discussion around the most appropriate methodologies to model this. ‘Black swan’ events are becoming more believable. Tools which can model such events, which fall outside of the usual standard deviations, are on the comeback, having fallen off the agenda in recent years.
To summarise, I recommend treasurers ask themselves the following questions:
- Are the worst case scenarios and stress tests you currently perform still truly appropriate and reflective of today’s risks?
- Are the underlying models used to generate the forecast still robust and free from error? Also, are they still appropriate and do they really take account of potential binary events?
- Do current KPIs need to be revisited, or new ones implemented?
- Is the reporting generated fit-for-purpose and do you know if it meets the requirements of the end users?
- Are process efficiencies and automation opportunities that were previously not considered cost effective now appropriate to focus on?
- And most importantly, are your action plans in respect of events that could lead to liquidity shortfalls and funding requirements up to date?
If the answers to any of these questions raises concerns about your preparedness or ability to respond to these very real risks, please get in contact with us.