Capabilities

5 Tips to Developing a Successful Liquidity Plan

  • Dennis
  • September 2, 2020

At the end of last year, economists disagreed whether we would see an economic downturn or even improvement of economic growth after sluggish 2019. With the Corona pandemic, economic activity has basically come to a sudden stop.

Unlike previous recessions, this is not driven by financial factors – but by an external, physical restraint. As timeframes are uncertain and governmental guidance varies, managers must make it their number one priority to keep their business alive – and manage cash more tightly than ever. For many finance functions, cash flow planning is a tool used in “times of peace” and includes annual budgeting, M&A or PPA (purchase price allocation). In such cases, an “indirect” approach is applied – with the cash flow being derived from a balance sheet and p&l, alongside assumptions on working capital and investments. This gives a strategic or macro-perspective of a business’ ability to generate cash over a mid- to long-term horizon – let’s say a 3-year planning horizon in annual intervals.

An indirect approach cannot be used with business (and incoming customer payments) almost coming to a full stop and cash being extremely tight. Instead, companies need a toolset for the very short-term in a micro-perspective – much more operational than strategic. Questions need to be answered such as:

  • When will our customers pay us?
  • On what date will our next payment run? Which customers will pay us by this date given the payments we need to make?
  • How do my personnel-related cash-outs change with short-term allowances (e.g. German Kurzarbeitergeld)?
  • When are taxes and social security charges due? On which date does our direct debit for VAT happen?
As timeframes are uncertain and governmental guidance varies, managers must make it their number one priority to keep their business alive – and manage cash more tightly than ever. Dennis Bücker, established restructuring consultant with experience in corporate finance and operational improvement.

Implementing a direct liquidity forecasting process is the tool to do just that – forecast the movements in your bank account on a weekly rolling basis, for a 12-15-week period. Direct liquidity planning for large, multinational groups have very particular aspects – such as capital transfer restrictions, withholding taxes, cash management across multiple legal entities, cash pool mechanics and securitization, etc. This is explicitly not in focus in this article. Rather, this short article focuses on the challenges for managers and finance practitioners of small to mid-sized firms. The following five lessons learned may give some insight gathered from real-world experience.

  1.   Find a bullet-proof process for cash-outs

With Corona measures in effect, you likely need to put great focus on cash-outs, as incoming customer payments may be scarce. Most businesses cannot afford to be surprised by cash-outs, it thus becomes a necessity to find a bullet-proof process for the completeness of cash-outs.

To get started, two sources of data should be looked at: a) actual data and b) forecast data. Getting a grip on actual data is relatively simple – the creditor's open item list of your accounting system contains information on cash-outs, mostly for the next 10-30 days. In addition to this, an analysis of past bank account movements can go a long way (e.g. for payments such as rent, interest, regular direct debit). 

With forecast data, information may be widespread, depending on your business. Information may be available with financial planning tools, booking systems or from department heads. The importance of directly talking to colleagues cannot be understated. Ask yourself, “For each type of cash flow, where can I find the most comprehensive information?”

In most businesses, bank account movements are driven by a few major positions (e.g. large customer payments, materials, rent, or personnel expenses). Strive to get those big items exactly right.

  1.   Don’t lose sight of the big picture

Liquidity forecasting requires a detail-oriented process. Updating forecasting week after week may become repetitive and easy to get lost in detail. Holistic liquidity forecasting requires assuming four perspectives:

  • The accountant takes care of accuracy, timeliness, and completeness
  • The controller coherently reflects the business & available forecasts and learns from measuring deviations between actual vs. forecast
  • The communicator gathers relevant information and buy-in by all parties – regarding data and potential measures to improve liquidity
  • The manager brings results and action-orientation to the team and supports with clear and swift decision-making
  1.  Develop practicable measures early on

In the current environment, liquidity forecasting serves one key purpose – keeping the business alive. Thus, the development and implementation of practicable measures are much more important than a 100% methodologically correct tool.

To achieve this, get a feeling for cash leakages and potential measures for management to implement as soon as you can. Establish a weekly discussion with the directors of the firm, instead of just reporting to them. They need to know to act! Practicable measures also mean defining clear responsibilities: one person must be responsible for forecasting; and for each measure, it must be defined who exactly does what by when.

  1.   Start simple, build in feedback loops and learn fast

Start fast – with a simplistic model that captures the big items. Acknowledge that not everything will be 100% accurate from the get-go. Instead, find the root cause for deviations week after week and improve gradually from feedback loops. Don’t be afraid of manual work in the beginning – this way, the practitioner will get a much better feeling for cash-ins and -outs. Start automating only when the process is well established.

  1.  Keep it honest and communicate actively

Liquidity forecasting must present a real, honest perspective – rather than an equity story or a worst-case scenario. If in doubt which cash-ins and outs to include or exclude, realize the purpose of the exercise – to identify the firm’s remaining financial leeway and the weakest links that must hold (such as collecting a customer payment within a certain timeframe). In many cases, a lot of judgment will be involved. 

I’d encourage you to talk to the colleagues who are closest to the matter and seek to understand what’s happening because the more actively you communicate, the more buy-in you will achieve.