Flexibility to be More Than a Stable Cash Distributor

The Citi-sponsored summer 2014 meeting discussed a range of topics starting with the need for financial flexibility in capital management, alternative approaches to supply chain and related financing, cash forecasting methods and a comparative review of member treasury organization charts. 

When members of The NeuGroup’s second group for treasurers of large MNCs met in September 2014, they expanded on last meeting season’s focus of process efficiency and innovation. The undercurrent of this meeting was to position treasury as a provider of capital structure and financial flexibility to enable large-cap MNCs to pursue real growth and not just remain stable cash distributors for investors. Also discussed was how members are reassessing supply chain strategies for financial and commercial risk mitigation, and how members continue to improve cash forecasting processes to streamline efficiency and improve forecasting results. Further highlights from the meeting included:

1) The Need to Maximize Financial Flexibility. An area of growing attention by treasury is involvement in improving working capital for both their own firm and key suppliers and customers. While improving working capital offshore contributes to the offshore cash dilemma, members also saw the benefits of helping different segments of suppliers improve their working capital financing via programs that leverage the member firms’ credit/payment standing.

2) Alternative Approaches to Supply Chain & Credit Risk Management. In addition to being a funding tool, trade-backed financing programs can be used to transfer the concentration risk or other unwanted exposure to suppliers to the investors in the paper.

3) Cash Forecasting Update. Members discussed how improved cash forecasting can be another aid to financial flexibility and helps fund growth via a better understanding of external financing need. One member shared a project that his treasury has undertaken to produce a better or more accurate cash forecast with less effort using historical data.

4) Treasury Org Chart Review. This session was a comparative review of members’ treasury organization charts revealed some interesting things for treasury transformation projects. One takeaway: while all acknowledge the benefit of rotational programs, several members noted the importance of continuity in key treasury roles and recent rebalancing of roles included in rotational programs.

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Leveraging Working Capital for Flexibility

The financial crisis and the uncertainty created by it have underscored the need for corporates to favor financial flexibility with capital management. To shed more light on how to preserve financial flexibility, this session framed the question with a discussion of what is optimal capital structure, how treasurers can support it, and how rating agencies, S&P in particular, are changing their methods of rating capital structure soundness. Citi led led the first part of the session focused on what the goals of optimal capital structure should be and the tools treasurers can use to help achieve it.

KEY TAKEAWAYS

1) Enabling growth or sustained distribution? Large-cap MNCs over the last several years have become more platforms for stable cash distribution to shareholders and less platforms to enable dynamic growth. Thus treasurers need to press their firm’s senior management to determine the extent to which they want capital structure to maximize flexibility to achieve growth or return cash to shareholders. If flexibility becomes more of the driver of capital structure, as opposed to cost of capital optimization, then large-cap MNCs will be in a better position to flip the switch to become more than just a stable cash distributor.

2) Distress is costly and limits options. Higher leverage is often employed to create value through capital structure and minimize capital costs via the tax benefits associated with debt financing. It is important for the capital plan to consider, however, the costs associated with financial distress and before that, falling off various rating cliffs. For example, Citi estimates that the loss of an A1/P1 short-term rating for CP leads to a 9 percent decline in firm value (up from 5 percent pre-crisis). The loss of an investment grade rating is associated with an 8 percent decline in firm value. Actual financial distress (equated with a rating of CCC+ or below) results in a 15 percent loss in firm value. Thus, successful capital management will create flexibility and mitigate against the cost of financial distress.

3) Treasury transformation adds additional value. Treasurers add value by supporting capital management that emphasizes flexibility, but their efforts at treasury transformation add to firm value too. A recent study by INSEAD, using Citi Treasury Diagnostics Data, suggests that treasury functions active with treasury transformation projects (characterized by those depicted in the graphic below) lead to on average a 10 percent higher Tobin’s Q (the ratio between a physical asset’s market value and its replacement value). In addition, treasury transformation efforts lead to cost reduction in the form of an average 5 percent lower cash-to-market value ratio and greater operating efficiency in the form of an average 1.44 percent higher return on assets. In addition, treasury efforts to improve working capital, advance cash visibility and accessibility, along with mitigating risk, all goals of treasury transformation, enhance flexibility in the capital structure which ultimately adds value too.

OUTLOOK

Treasury can describe its value-add as a flexibility multiplier that uses treasury tools like liquidity, cash and working capital management alongside support of a capital plan that will enable firms to pursue real growth as well as distribute cash to shareholders.

Supply Chain and Credit Risk Management: A Alternative View

Citi led this session providing an overview of trade receivables and payables profiles of T30-2 member companies with suggestions of how they might fit into members’ funding mix. Citi also called upon members using receivables-backed financing to share their experience with it.

KEY TAKEAWAYS

1) Trade paper significant to capital deployed. Accounts payable balances are a substantial component of the capital deployed for the T30-2 meeting participants, approaching almost 40 percent of the outstanding debt and almost 10 percent of total assets. On collections side, trade receivable balances are a substantial component of the capital deployed for the T30-2 participants, approaching 35 percent of the outstanding debt and almost 10 percent of total assets.

2) More should be pursuing trade-backed financing initiatives. Given the above and the sizeable and highly predictable cash collections on these trade payables and receivables, it would be natural to assume they would form a key component in various financing initiatives for the T30-2 participants.

3) Increasingly competitive alternative to revolver financing. Depending on the firm’s credit profile, trade-backed financing is becoming competitive to the cost of bank revolver financing (being driven up by bank regulation, which also favors collateralized financing) and even CP, for A2/P2 issuers (exacerbated by money market reform).

4) Contingency funding source. Even stellar credits may want to consider a program, as one member has, in the context of contingency funding. To ensure ample liquidity when access to other funding sources are unavailable ABS financing using trade receivables can fill gaps.

5) Working capital improvement not always attractive enough. As cash-rich multinationals, the prior bullets may make trade-backed or supply-chain financing programs more interesting. As several members noted, improving DPO or DSO numbers offshore just exacerbates their offshore cash problem.

OUTLOOK

Part of the problem with trade-backed financing and supply-chain finance discussions is that they get focused solely on the working capital improvement argument, which is important, but not the sole benefit to be won from such programs. These other benefits will only grow as innovation in trade-backed structures continue and non-bank investors provide the funding. In an earlier session, one member suggested looking at structures in Brazil to help with affiliate pooling and netting, which is another example how innovation in trade-related structures might solve problems in other areas. Several members also noted the potential on the investment side, as funds they may choose to invest their cash in might be increasingly purchasing securities backed by quality MNC trade obligations.

Designing a Better Forecast

One member updated the group with details of his new cash forecasting project, which was begun earlier this year. The project seeks to use direct cash-flow data and historical trending to build a more efficient and an at least as accurate a cash-flow forecast as the current one based on line of business forecasts. The new process being tested starts with bank account data, adds inputs such as tax payments, studio production spend capex, international cash balances, adjustments for M&A and cash in-transit, and performs regression analysis to come up with a cash forecast.

KEY TAKEAWAY

1) Tap quant resources. In this company’s case, treasury tapped the quant resources from a revenue management group within its one of its businesses to help devise a new forecast methodology using statistical analytics. They developed a time-series model that uses over five years of historical data to produce a rolling 12-month forecast at the segment level.

2) Determine if treasury is supplementing or replacing FP&A. Treasury usually gets involved with truing up the corporate cash forecast to assess true liquidity and funding needs. As a result, treasury often is inclined to see if it can extend this effort to supplement, advise on or replace the corporate cash forecast usually owned by FP&A. No one likes cash forecasting, so FP&A as well as the business unit managers that feed it information will be all too quick to give it to treasury. Before letting them, members warned that treasury should consider the accountability and incentive dilemmas this can create. For example, how does the CFO reconcile vast differences between the cash forecast and performance target set by a given business unit?

OUTLOOK

Since forecast accuracy is a perennial challenge for large corporates, the presenting company’s attempt to streamline the cash forecasting process without sacrificing accuracy is one that most members will want to at least consider. Its model has so far proven to be very accurate, with segment or line of business error rates averaging 3 percent of accounts payable and 2 percent for accounts receivable. Results over the last three quarters, moreover, show that treasury’s new method is showing less forecasting variance than the current FP&A-owned process (10 percent vs. 16 percent).