Enterprise liquidity management is no joke. Keeping tabs on working capital is hard enough for SMEs, and they don’t even have to worry about complying with regulations in 15 different countries.
It’s true – liquidity management is tough, but for large, multinational companies it’s like turning the dial up to 11. You have to keep on top of working capital across subsidiaries, monitor ever-changing exchange rates, and move capital without incurring hefty taxes.
While the stakes may be higher, and the variables more numerous, it is possible for large companies to manage liquidity as tightly as much smaller organizations. All you need is the right strategies.
Choose Your Strategy
And that’s your first step: picking your overarching, liquidity management strategy. Our partner JP Morgan outlines three: physical concentration, notional pooling, and overlay structures.
This is a centralized approach, where you’d put everything into a single bank account. The benefit is clear – you only need to look at one account to understand your entire liquidity position. You can then disburse funds from this account to different subsidiaries as required.
While it’s neat, and reminds us of a sort of centralized mission control like the Batcave, physical concentration isn’t necessarily ideal. The big drawback is you’ll constantly have to deal with costly exchange fees. It’s also going to be just about impossible to implement for companies with many entities.
This strategy is the opposite. Everything is kept in separate, regional accounts. So what makes it special? Well, the thing about notional pooling is that it allows you to calculate interest rates as if all the money were in one account and denominated in one currency. Keep in mind, however, that this strategy can attract attention from auditors and tax authorities.
This strategy combines the best of both worlds: it involves letting regional banks do their thing, but introducing an overlay bank on top. The overlay bank automates balance collection through an end-of-day sweep – however, that does mean early cut-off times can have a big effect on this method’s efficiency.
Which option you choose can depend on your organizational structure and culture. You may have a distributed system, where regional treasuries have a lot of say over their own operations – how they manage liquidity, how they hedge against Forex risk, etc. Or, you may have a centralized treasury that’s managing these aspects company-wide.
Regardless of which treasury strategy you use, the components of enterprise liquidity management remain the same.
Manage Working Capital
Working capital is a measure of current assets and liabilities. But keeping tabs on it is about much more than short-term liquidity management – it’s the basis of long-term growth. With a strong working capital position, you can seize opportunities as they arise, respond flexibly to crises, and access cheaper financing.
Managing working capital as a multinational company involves allocating the right amount across subsidiaries. This means keeping an eye on currency fluctuations, as these will directly affect the value of accounts payable, receivable, inventory, and – of course – cash in different regions.
If the value of a currency in one region declines, you may have to move cash across borders in order to compensate. Figuring out the best way to do this – depending on the circumstances – is one aspect of your working capital strategy.
Repatriation of cash is moving it back to your home country. There are two primary methods of doing this: distributing dividends from subsidiaries to the parent company and intercompany loans. To decide between them, you’ll have to consider tax implications – for instance, dividends may be subject to withholding taxes, while intercompany loans can attract interest income taxes.
You also have to consider cash flow needs – how urgent is it to get that money from one place to the other? Intercompany loans can be structured with repayment schedules that may not align with immediate cash needs. One thing they’re great at, though, is getting around high income tax rates in the subsidiary’s country. Other creative ways to repatriate money include management fees or – in the cast of home-country based intellectual property – royalties.
Whatever you do, make sure it’s compliant with local tax rules.
Of course, you might also just keep it there and reinvest it in the country. It all depends on your total liquidity picture.
Fight Forex Risk
When dealing internationally, exposure to foreign currency is unavoidable. Naturally, this presents risk, as the value of that currency to you will change constantly. There are a few different options to mitigate this risk. Natural hedging is the most obvious. Also known as matching, natural hedging involves matching inflows and outflows to pay suppliers – you’d keep different accounts denominated in different currencies, keeping everything separate.
Another option is forward contracts, where you lock in the current exchange rate and agree to exchange a certain amount of money at a specified date.
Finally, you have currency options, which give you the option to exchange currency at a fixed rate (or not).
Of course, the degree to which you decide to hedge depends on your appetite risk and your overall wiggle room in cash flows.
Mergers and Acquisitions
There are few areas where foreign exchange risk becomes as obvious as with mergers and acquisitions. If the M&A is in a foreign country, you’ll be using the local currency for valuation as well as funding. If exchange rates shift – and they will – that could undermine the financial outcomes of the M&A transaction. The usual options such as forward contracts can be used to guard against such risk.
But there’s a whole other aspect to M&A – cash flow. Cash flow integration is a difficult process. However, with the right forecasting methodology, you can ensure the process goes smoothly. Build solid cash flow forecasts for both the acquiring company and the company being acquired. Once again, it all comes back to working capital. Determine the working capital requirements of the entity being integrated, then match inflows and outflows.
Visibility: The Key Piece to Enterprise Liquidity Management
All of the above really depends on visibility. Visibility of regulations and tax implications, currencies and cash flows, even the geopolitical landscape.
For the first two, you have your legal team and accounting. For the last, you have CNN. But how are you supposed to attain visibility when you’re dealing with dozens of bank accounts, across continents and currencies?
The answer is through APIs. A recent development in the banking world, APIs allow direct communication between banks and third-party software. The idea is that you connect transaction data from all of your bank accounts to a centralized platform. All of your bank accounts, across entities and regions.
We probably don’t have to tell you how beneficial that can be. Take working capital. With APIs, you can see your accounts receivables and payables, and what currency they’re denominated in. You can see how much each entity has and, if you need to move liquidity from one to the other, you can do that – all from this centralized platform.
With a clear view, you’ll know when it’s best to repatriate cash, and when it’s best to reinvest it. Large companies have a lot of options: capital expenditures, investments in subsidiaries, dividend payments, etc. When you see exactly how much liquidity you have on hand, as well as the overall landscape, you can figure out where that money will have the best, most targeted effect.
You can then view the breakdown of your global cash holdings across currencies, so that you determine what your risk is and adjust if necessary. You also ensure you have enough of each type of currency, avoiding regional short flows in working capital. With a centralized platform, you can optimize cash balances and reduce idle cash across subsidiaries.
How Automation Can Help
Recording transactions across the massive volume of multinational enterprises can be near impossible without automation. Each subsidiary has to record their own, then send them up the chain of command – all with the risk of manual error. Those errors add up, resulting in a distorted picture of your situation. With automation, there’s no risk of error – when a slight inefficiency in working capital can cost huge amounts of money, or expose you to credit risk, that’s crucial.
Based on this real-time and historical data, you can then forecast cash flow individually, across entities. Better yet, you can create forecast rollups, combining everything into one, consolidated forecast.
The right software allows you to remain decentralized, while also centralizing your view. You don’t have to resort to a strategy like physical concentration to achieve that financial Batcave. Even if subsidiaries are acting somewhat independently, the ability to see how their decisions affect the larger company can’t be understated.
The goal is to make the leap from “just” cash accounting – that is, ticking your boxes – to actively building a strategy that hedges against risk and fortifies your financial position. You use each piece to play off the next, maximizing your liquidity internationally.
Bring Liquidity Management to the Next Level with Trovata
Each piece – optimizing working capital, moving money, and managing forex risk – is one part of a successful liquidity management strategy. But each depends on visibility. Thanks to new technological developments, something that was unimaginable just 10 years ago is now commonplace. Companies as large as IBM and Coca-Cola use APIs to achieve near real-time cash visibility.
Trovata can help you gain cash visibility, no matter how large your company. More than that, it can help you strategize, ensuring each piece of working capital is working for you and that each entity is doing its part to contribute to the whole.