READING MATERIALS
READING
2.2
Range forecasting and behavioural considerations
The COVID-19 context demonstrates the difficulty of providing accurate cashflow forecasts in an uncertain economic environment, and reinforces the point that a simple ‘single point’ forecast based on a system/technology that looks at trends simply will not work. Uncertainty in the world around us makes life for the treasurer very challenging indeed.
It is clear that cashflow forecasting is critical for an organisation, and one’s assessment of the level of accuracy of a forecast will determine how much ‘buffer’ cash is needed at any time. So, the greater the uncertainty, the greater the buffer needs to be. A technique which can help in this is called ‘range forecasting’. This does not require complex systems, though they can be integrated into the process. It does require knowledge of the business, and discussion with colleagues though.
So, instead of asking colleagues what their forecast is, and they come back with one number, and possibly some risk and opportunities around that number, you ask the questions: How good could it be? and How bad could it get? This gives a range, and in discussing that range you really start to understand the risks and opportunities of that part of the business. You then discuss what is the most likely outcome, and that point is unlikely to be right in the middle of the range. This forms a statistical probability curve, and you can add up the different parts of your business and then cut off the outlying parts of the overall set of curves to come up with a reasonable range of outcomes.
Figure 9: Range forecasting
The beauty of this process is that you start to really understand the risks, opportunities and likelihoods of any outcome. You break down some of the behavioural barriers such as those within departments who are always over-optimistic on revenue, or alternatively constantly ‘low-balling’, as well as those who overstate costs so they can keep their own contingency. Experience from large multinationals demonstrates that unless there is a behavioural shift, you can be faced with contingency upon contingency within the organisation’s consolidated forecasts (as well as budgets of course), which leaves you to second-guess others to get your forecast in a reasonable state such that you can rely on it for decision-making, and this can be a dangerous game. Another benefit to the process is that you get to know your business even better, and you thereby further gain the respect of your colleagues.
You can implement this in full, or alternatively use elements to ensure you are having the right discussions across the business – and in times of great uncertainty these conversations are invaluable. As you do not need complicated systems to adopt this approach, it can work well in any organisation in any situation, as long as the definitions of what you are asking for are very clear and consistent across the organisation. Range forecasting works best when you have a number of units or divisions or countries you are consolidating – the more, the higher the likelihood of overall accuracy.
READING
3.3
Short-term financing instruments
There are many ways in which a company can obtain external short-term financing. The lenders fall into three broad categories: banks, the financial markets and commercial credit solutions. Note that although in the context of cash management we focus on short-term debt instruments, in many cases these are accessed by putting long-term credit lines or facilities in place. Such facilities must be entered into on the understanding that they impose long-term rights and obligations on the parties and these are likely to influence how the short-term position is managed.
Uncommitted credit lines (facilities), for which there is no additional fee, do not oblige the lender to lend and are primarily used for intra-day financing or for purposes such as foreign exchange transactions or trade finance. Committed facilities oblige the lender to lend so long as the borrower complies with the terms of the facility agreement. They are used for core financing and tend to be longer term. ‘Evergreen’ credit lines are facilities that are routinely rolled over rather than repaid.
SHORT-TERM BANK FINANCING
The following is a summary of the characteristics of traditional vehicles offered by banks for short-term financing.
Overdrafts
Overdrafts are highly flexible sources of short-term financing that can be put in place in advance of being required and can be automatically triggered in the event of an account becoming overdrawn. However, they are repayable on demand from the bank and generally incur relatively higher rates of interest than other types of financing and therefore are unsuitable as a long-term source of funds nowadays (historically, however, for instance in the UK, overdrafts were in effect one of the few sources of longer-term funding – but times have changed).
Money market advances
Money market advances are available in most major currencies and are arranged through the bank’s corporate dealing or money market desk. Generally unsecured, they are available to more highly-rated companies and offer a lower-cost source of funds for up to one year. Interest rates are generally a margin over the bank’s money market rates and are therefore cheaper than overdrafts.
Revolving credit facility
A revolving credit facility (RFC) drawdown can be made to meet short-term requirements (generally between one and 12 months). A long-term RCF can be put in place in advance of any financing requirement and can be drawn, repaid and redrawn as frequently as required within the terms of the agreement so long as there are no events of default.
Figure 2 summarises and compares the characteristics of the three major bank borrowing facilities.
Figure 2: Methods used to borrow funds
*prime rate is the interest rate banks charge their most creditworthy customers
Invoice discounting
Invoice discounting is a process where a borrowing is obtained based on a future receivable from a customer. The bank will provide a certain percentage of the invoice amount today and when the customer settles the invoice, the bank will claim the full amount. For example, company A has a financing need and has issued an invoice to customer X for AUD1,000 due in 30 days. The bank agrees to provide a loan of AUD970, and the company will pay them back AUD1,000 when the customer pays the invoice.
Invoice discounting can be either at non-recourse or recourse basis. The difference between recourse and non-recourse relates to what happens if the customer does not pay. With recourse, the bank has the right to reclaim the funds it has advanced if the customer does not pay. With non-recourse the bank takes the credit risk of the customer, i.e. it cannot reclaim funds advanced if the customer does not pay.
BORROWING FROM THE FINANCIAL MARKETS
For some companies, financing is available from sources other than banks. Major instruments used for borrowing directly from the financial markets include:
Commercial paper
The characteristics of commercial paper (CP) are:
- short-term (usually), unsecured promissory note
- maturities vary from one day to one year, but most are issued for 30 or 60 days
- in the USA maximum maturity is 270 days to avoid registration with the SEC
- mainly denominated in USD although Euro CP enables other currencies to be used, such as GBP and EUR; programmes are rated by the credit rating agencies – highly-rated paper attracts the finest margins
- cheaper than bank borrowing but other fees are associated with the issuance
- interest rates are usually lower than bank financing, depending on the credit rating of the issue or issuer
- a dealer is used to handle the issue and its distribution
- usually issued on a discount basis
- repayment (commonly financed by issuing fresh CP) is not secured so committed standby facilities or guarantees are often required to enhance the credit.
Repurchase agreement
The characteristics of a repurchase agreement (repo) are:
- selling a security to raise liquidity, with an agreement to buy it back at a certain price on a certain date
- this is the other side of a ‘reverse repo’ investment transaction
- usually done on an overnight or very short-term basis using highly-rated securities such as treasuries.
First published 2016. Updated and republished 2022.
Published by: ACT (Administration) Limited www.treasurers.org
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