Rapid changes in the macro environment

In line with the increased financing costs, the management of interest rate risk – and thus liquidity risk – and the availability of cash have moved up on the corporate agenda. Since this usually involves the use of derivatives, hedge accounting issues must also be given greater consideration.

The liquidity topic has been affected in recent months not only by the interest rate hikes, but also by the massive fluctuations in commodity prices. Price volatility in the energy sector has been unprecedented – the price of a barrel of European Brent crude oil, for example, rose by more than 40% from January to June 2022, while the price of natural gas advanced by 50%. At the end of September 2022, Brent crude futures were trading at $86 per barrel, a quarterly decline of more than 20%. Volatile European natural gas prices declined significantly from their peaks but are still extremely elevated. Industrial metals also showed significant advances in the course of the year.

Hedging has its limits

These striking price movements have had – and continue to have – a significant impact on companies. The extent of this impact varies from industry to industry, of course, but the pressure on margins is weighing on many companies' income statements and has depleted liquidity reserves. Companies without active risk management face major challenges. Even organisations with hedging programmes in place are reaching their limits, for instance – but not only – in the energy sector, where they have to meet margin calls to provide additional collateral, which has a massive impact on liquidity. Hedging strategies can only bridge a certain period of time, and a fundamental rethink of a company's long-term operating model and strategy is required. Alternative energy sources need to be found and more efficient operations need to be introduced.

Adding to this mix of liquidity squeezers is the appreciation of the Swiss franc. On the one hand, Swiss family and private businesses tend to think in terms of their home currency. They have historically been the losers in exchange rates, as the Swiss franc has appreciated more or less continuously against major currencies over the past 20 years. On the other hand, international companies have been exposed to significant exchange rate fluctuations. Companies need to find solutions to shift currency risks to suppliers and customers as well as optimise internal processes and the use of cash to ensure maximum compensation or achieve a natural hedge.

Access to liquidity is key

Why is liquidity risk management so important in volatile markets? In our practice, we often find that companies still have fragmented cash holdings in many different countries and jurisdictions and with many different banks. This disparate banking landscape creates high fees and limits access to cash. In addition, internal processes do not allow for easy transparency as the supporting technology is often inadequate, further limiting transparency and access to cash. Such fragmented (technological) structures can also increase operational and cyber risks. All this leads to many companies only having a complete overview of free cash on a monthly basis and/or through manual reporting, leading to lack of transparency and more risks.

To achieve consistent access to cash, the first step for companies is to keep track of free cash across the organisation. Only when cash is viewed as a corporate asset – as opposed to viewing cash as a "local" property – can the treasury put cash to work where it adds the most value.

Best practice means technology and sound strategy

In a best practice setup, a central treasury has daily and automated visibility of cash; an automated cash pooling setup – or virtual accounts or an in-house bank – provides the treasury with the necessary control over liquidity. With the help of a cashflow forecasting system, the treasury team gets a good overview of the organisation’s operational liquidity needs for the next, say, 12 weeks. It can then actively manage any excess liquidity over various time horizons – from short-term up to 12 months – but also deal with structural excess liquidity. This means that liquidity can be used to repay external loans, fund M&A, pay higher dividends or transfer funds to an asset management portfolio.

Liquidity management or cash management optimisation gives a company the opportunity to reduce its dependence on external financing, ensure better use of cash, and achieve higher returns on longer-term investments. 

Especially in times of crisis, access to and control over cash has proven to be a game changer, as it provides alternatives to more restrictive external borrowing, as well as access to a war chest to finance M&A projects at times when other companies are focused on internal problems. Since the outbreak of the pandemic, liquidity management and forecasting have been a big topic, but further stress factors are yet to come. Crises have shown that organisations that were prepared, were able to outperform their peers and benefit from growth opportunities.

How to prepare for the future

Being prepared for challenging times requires taking adequate and sound measures and implementing the necessary processes well before the crisis occurs. Companies on their path to optimise the handling of their cash should start with an initial assessment and develop a treasury vision, for example in a workshop on understanding the status quo and discuss a potential target state in line with their overall corporate strategy.

Based on these findings, the roadmap from the current to the target state can be assessed and the business case for change developed. This includes a series of tailored change initiatives in the areas of organisation, banking strategy, cash management, financial risk management, funding and investments, technology, and governance.