International companies are heightening their focus on multicurrency cash flow forecasting in light of increased currency volatility.
“Cash flow predictability is critical to a successful hedging program,” said Paul LaRock, Principal at Treasury Strategies, Inc.
“Businesses are using cash flow forecasting to better understand foreign currency inflows and outflows for their operating units. Gaining cash flow predictability and visibility enables a disciplined approach to deciding whether or not to hedge.”
Receivables: Understand the gap between sales and collection
Companies are devoting more time and resources to understanding the timing gap between sales and collection.
“One of the important things about working capital management relative to foreign exchange (FX) hedging is the risk period,” LaRock said. “The longer the window of time between booking a sale and collecting a payment, the greater the risk.”
What are companies doing to increase the predictability of collections?
- Collaborating with internal business partners. It’s important to work closely with operating units to increase the predictability of the timing and amount of collections.
- Performing a formal variance analysis. Understanding and eliminating variances is critical to an accurate cash forecasting model.
- Collecting in functional currency where possible. To a more limited extent, where customers are amenable, some companies are trying to sell more in their functional currency.
Payables: Longer terms increase currency exposures
The relationship between working capital and FX risk is different for receivables versus payables, LaRock said.
The goal of collecting payment for sales as quickly as possible aligns with an objective of shortening the duration of foreign currency exposure. However, a strategy of improving working capital by lengthening vendor payment terms also increases the risk period for foreign currency fluctuation.
LaRock noted that gaining predictability over invoice and payment timing mitigates the risk associated with elongated payment periods.
“In extending payables, companies must consider the potential additional expense of hedging for longer durations, which can reduce the benefit of extended payment terms,” he said. “Companies need to find the right method for their business to compare the working capital benefit versus the impact on hedging costs.”