Aug 29, 2020

Cash flow: unlock hidden value and manage risk

While market conditions can change over time, one element remains valid for every company: Cash is King. Still many companies struggle to put in place an effective strategy to manage their cash flow or they look to external funding sources before looking internally.

A structured approach will not only add liquidity to sustain operations and fund growth but also adds a layer of stability during difficult times navigating rough patches.

In this article, we’ll explore three cornerstone practices underpinning the process of successful companies:

  • Reinforce best practices for working capital management
  • Create a Cash Flow forecast and establish a discipline for review
  • Develop scenario planning and stress test

Build the foundations: working capital management

Receivables, payables and inventory are the three overarching elements of working capital. It is essentially the ability of a business to meet its short-term obligations. Businesses could be profitable on paper but still be at the brink of bankruptcy as they fail to meet their financial obligations. Any plans to improve cash flow should start by dissecting and addressing each of the three working capital elements


A first step is to define the credit terms and payment policy that works for a business. This approach, even if done correctly, may not be enough. Very often too much focus on generating new sales means that a strict payment term in place would be circumvented and replaced with a more relaxed one to win business transactions. It can happen that payment terms are extended to win new clients or customers are granted discounts or even paying late because there is not a formal process to follow up. This is often a case of trade-off between liquidity and profitability. Therefore we find three key focus areas on in optimizing receivables:

  1. Strengthen the link between finance and sales: Both departments need to work together to find the payment terms that are reasonable for both the customer and the company. Once the policy is defined it is useful to review the client database (customer master data), check anomalies and agree on them (if the policy says net 30 days then customer master data should not contain 60 days for example).
  2. Create an efficient billing process: Automation is the key element here, but even with automated processes invoices could be riddled with errors and/or not sent to customers on a timely basis. This could be due to inaccurate data or multiple approvals/ steps in the process. Focus on creating a lean process, set an internal deadline to send the invoice (same day from the PO is signed or within 1 day). If you have invoices with incorrect data define the owner of customer master data.
  3. Adopt a regular schedule and strategy to follow up on collections: First make sure you have a clear view on your accounts receivable report (aging) and define a review mechanism either weekly or monthly. Then, plan your strategy to follow up on delinquent clients. This could change based on your industry and type of client, but it is useful to define when a reminder should be sent and what is the escalation process. It is part of the finance department’s responsibilities to follow up on payments, but keep a close loop with sales and ask for their support when necessary.


In contrast to receivables where you set your terms for others to respect, payables require you to follow somebody else’s terms. Payments terms can change widely across your supplier base creating both opportunities and challenges.

The best way to take advantage of the situation is:

  • Pay attention to payment terms: Most of the time the focus is on the price. While price is extremely important make sure it is not the only criteria as payment terms should be one of the key aspects in your vendor selection. When you evaluate a new vendor always negotiate on terms, for example minimizing advance payment if required or agreeing to credit term that works in line with the forecasted cash in a cycle.
  • Increase visibility: the risk in many cases is that your P2P (procure to pay) process is not strong enough to provide reliable data. This can create a larger problem in terms of visibility and planning. Key points to focus on: Purchase order (PO) creation and invoice matching promptly.
  • Optimize timing: It may seem strange but there are situations when invoices are paid before they are due. Make sure this is not a typical thing in your organization (because that means your policies is not adhered to), but exceptions could be made provided that it also works in your favor. For example, if your planning shows that you have surplus cash you can take advantage of the situation by paying early to suppliers who would offer early payment discounts.


Not all the companies have inventories and this could be a completely separate topic for many of them, but when present it is one of the areas where most of the cash is trapped. There are key principles to keep in mind in any case:

  • Define minimal inventory levels: This is up to your specific industry and company, but you should define what is the minimum inventory level and module between having sufficient stock to satisfy the demand and not having too much as it is not highly liquid.
  • Monitor demand patterns: You could have seasonality or holiday or hours of the day with spikes. It is important to understand how your demand changes as this will help to optimize the correct inventory level.
  • Get a real-time view: There are several software that allows you to manage your inventory, but such software should be supported with internal controls to make sure you arrive at a real-time view on the quantity available (and location). This will help avoid over-purchasing when not needed.

Create a Cash Flow Forecast

Once you have laid the foundations you can start to monitor your cash flow and to plan ahead. Monitoring your cash flow becomes extremely important when there is a liquidity problem, but it can also help you to take advantage of surplus cash and plan how to use excess liquidity. The best way is for sure is to automate the whole process, but as this is not always possible, we suggest some practical steps to manage it.

Decide the period of forecast: First step is to decide the period of forecast, while it would be nice to see 18 months, it may not make sense in many cases. Decide based on your company and the reliability of data, the more the business is stable and has reliable data, the more you can extend the length. Once you define the period that is reasonable for the business to forecast (3-6-12 months), you will then roll forward once actual data becomes available.

Focus on output: Outputs should provide key results to aid decision-making. The complexity of the forecast can vary based on your company’s needs and size, but it should contain 3 key elements:

  • Operating cash: linking to balance sheet DSO (days sales outstanding), DPO (days payables outstanding) and DIO – days inventory on-hand
  • Investing cash (capital expenditure, disinvestment)
  • Financing cash (debt repayment)

The main goal of the cash flow forecast is to give actionable information, so it should be fit for purpose. Unless it is strictly necessary, do not build complex models that become prone to error and do not add more information. Keep inputs organized, processing simple and output clear.

Define a discipline for review: It could be monthly basis, but when conditions get tougher you may want to move to weekly review to improve visibility and reliability of information. Start focusing on monitoring the KPI (DIO, DSO, DPO). DSO shows how fast you’re getting paid and DPO shows how fast you’re spending money. So if your DPO is 30 days and your DSO is 60 days, you have space to improve. In an ideal situation you should have DSO<DPO, meaning your cash in inflow is coming faster than the outflow. Bring a structured approach of review to improve your ratios.

How to manage shortage and liquidity crisis: Stress test and scenario planning

Shortage and liquidity crises could derive from external factors (changing market conditions) or internal (operational inefficiencies). In both cases a key principle remains valid: you need to buy time. How long? Until you are able to implement the changes necessary or until market conditions return stable. Before tackling strategic or operational change you will need to understand how long is this time frame. Focus on solving the short term problem in order to be able to purse the long term goals.

Stress-test your forecast. Identify what are the drivers that can trigger a liquidity problem, define how this can impact your forecast and when/if the problem will arise (in one week, in one month..).

Create a scenario planning and course of actions for each scenario. Before you set your next course of action you should define a scenario planning. Identify the best case, medium case, worst case. For each case identify the period it will last and what measures should be put in place. Finding the balance is crucial, remember to pull all the levers and to pay particular attention on immediate actions that can create cash without affecting the business. Some practical examples include:

  • Don’t buy assets but lease. Sell the non-strategic ones (or if strategic sell and leaseback)
  • Reduce immediately non-strategic overheads
  • Focus on products and services with a higher margin
  • Prioritize less risky clients, where is more probable that payments will arrive on time
  • Pay attention to cost-cutting that has direct implications on business performance and not add cash benefit in the short term. Balance the grade of severity based on the scenario.

Keep an open communication channel: It can happen that you don’t want to damage the reputation of the company, but it is worse to keep delaying payments. You will not only damage the reputation but also lose the trust of your vendors. In case of crisis it is extremely important to open communication. Let your vendors know what is happening, why they’re not getting paid, and when they can expect payment based on your most reliable plan.

Creating discipline in your organization is what is required to optimize your cash flow. Being in control is what is needed to boost resilience and capture opportunities.

Set the foundations for cash flow management, create a structured approach to planning and review. In stressful circumstances take control of the cash and correct the short term situation without losing view on the long term.

Emilio Parente

Article author

Emilio Parente


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Aug 09, 2020

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