“We don’t bother with liquidity planning. It doesn’t help anyway and only causes us more work. We just use balance sheet and P&L data.” We often hear these and similar arguments from our customers when it comes to liquidity forecasting. To me, this is a little bit like saying, “I don’t like using GPS when I drive somewhere because the estimated time of arrival is always off anyway. I’d rather rely on train or air traffic schedules to determine when I’ll be arriving.” So are people right to be critical and liquidity planning as an independent forecasting strategy doesn’t make any sense?
Only a few years ago it was still easy to dismiss liquidity planning simply by pointing out that it was too much effort and the results were far from reliable. However, the financial landscape has changed dramatically since 2008 and liquidity has become a precious good we can no longer afford to take for granted. It is more than a residual figure when it comes to preparing the balance sheet; liquidity is a crucial factor for any company’s survival – not derived from other figures but independent and prominent. It is therefore high time we faced the above raised concerns and looked at the possibilities for creating a solid basis for company decision-making and management. The question is not if we should be using liquidity planning but how to approach it. Where do we get the data we need? How can I achieve a valid result? It pays to discuss these questions and to find satisfactory answers.
The first step: we need to let go of the notion that liquidity planning is related to what we know from balance sheet and P&L planning. It would be very convenient but the automatic creation of a direct liquidity forecast based on data from other sources is simply impossible. Only once this has been accepted can we turn to liquidity planning and consider the following points without bias:
- Any plan, however rudimentary, is better than no plan and that makes it the best possible solution. Having no plan means embarking on the future without a sound footing. It means reaction instead of action. Only having a plan allows us to be in control of our decisions.
- Having a plan means having something to base our decisions on – decisions we need to make today. A forecast is not meant for us to look back at some indefinite point in the future to assess whether or not everything has gone exactly according to plan. It is not about the accuracy of the end result but about the very ability to make sound decisions within the framework of risk management and to take action or revise measures where appropriate – today and with view to the future.
- Liquidity planning is easy and independent of any other planning if you rid it of environment variables and simply consider typical liquidity flows: salaries, rent, customer payments, payments to suppliers etc. Based on these known parameters you can quickly prepare a liquidity forecast and this gives you a first indication of the risks treasury can and must take into consideration.
- The result at the end of a 12 month planning period is not the most important point but one of 365. Any day is as important as 31 December and a liquidity shortage on 5 September is just as disastrous as on the last day of the year. Companies simply cannot afford to only concentrate on the end of the month or the end of the reporting period – the risks are simply too great.
- This is not just about liquidity but also about currency risk which arises from the currency of denomination. The main point of liquidity planning might be to make sure that a company has sufficient liquidity but cash flows come in different currencies. This is why liquidity forecasting is always associated with two types of risk: funding and hedging.
- No data from other systems can simply be transferred and information from many different sources has an impact on a company’s liquidity. However, the questions of “how” and “when” require a “human interface.” No machine is able to qualify and quantify data in a way that would provide a sound basis for decision-making.
It follows that without planning I cannot make any decisions. And we all know how fatal decisions can be that were made without reliable information. This alone should be motivation enough. What is the point of a plan that shows sufficient liquidity at the end of the planning period but fails to record a gaping liquidity shortage throughout the year, if only for a few weeks? By only concentrating on the end of the year companies risk failing to identify lost revenue throughout the year that could have dramatic consequences and lead to the company becoming illiquid before it can recover. In addition, companies also risk starting funding negotiations too late which might prove a critical factor. This concerns all businesses, including big and renowned ones – there’s ample press coverage to prove that.
So the question shouldn’t be if liquidity forecasting makes sense. Given the alternative it always does. The crucial question is how liquidity planning can be implemented in order to make the most of it. And for that there’s usually an easy solution. So you can safely use GPS and use the estimated time of arrival – it will lead you to a more realistic and understandable destination than second hand data from other sources.