Boards of directors do not routinely scrutinise cash and liquidity resources, in my experience.
Their interest in this matter tends to be triggered by specific circumstances that cause them to concentrate on cash issues at short notice and in much greater detail than the norm.
Directors’ attitudes will depend where on the spectrum the organisation lies between a) the well-capitalised listed group with easy access to funds; and b) the cash-strapped entity struggling to survive.
Their perspective on liquidity and the accuracy of cash forecasts will contrast enormously. I take an illustrative look below at these two extremes, and then also cover some of the circumstances that can lead to raised scrutiny of cash availability and forecasts.
For large listed groups with easy access to funds via the equity and debt-capital markets, possibly backed up with a strong credit rating, the level of cash balances held within the business will rarely be a matter for board discussion.
In the UK, as a result of corporate governance arrangements, cash projections will commonly be reviewed in connection with the viability statement included in the group’s annual report. The board, in this forward-looking statement, will normally conclude that it has a reasonable expectation that the organisation will continue to meet its liabilities as they fall due.
This will be couched in respect of a specified time period, and a three- to five-year horizon is quite common.
It may be necessary to report cash balances to the board on a daily basis, and forward cash forecasts will be critically important
The board will review the organisation’s principle risks (plus mitigating actions available) and will consider the multi-year output of financial models projecting the likely impact of various scenarios.
Ensuring the organisation remains solvent with sufficient liquidity and complies with its financial covenants will be a key focus. The directors will refer to this analysis in the annual report to explain the approach taken in reaching their conclusion.
As part of the year-end audit process, the audit committee may also occasionally examine other cash-related matters, for example, whether the organisation has any trapped cash in specific jurisdictions that is not immediately available for deployment elsewhere in the group.
Here, the board’s focus will be entirely different.
There may be a real concern that the business might run out of cash and be unable to pay its liabilities as they fall due.
Individual directors may be concerned about their potential personal liabilities if they are found to have continued trading unlawfully.
If the organisation has borrowings, directors may run the risk of breaching financial covenants or other obligations, which could give the lenders the ability to require immediate repayment of their debts, or to enforce security over any pledged assets.
In such circumstances, there will be a very close focus on conserving cash reserves, possibly even at the expense of profitability. It may be necessary to report cash balances to the board on a daily basis, and forward cash forecasts will be critically important.
Indeed, in some circumstances, these forecasts might also be essential to the organisation’s eventual survival.
If the lenders can get comfort that the cash forecasts (typically extending out 13 weeks at least) are reliable, and these do not show a significant deterioration, then the search for an appropriate solution to the challenges faced may proceed on an orderly basis.
If the lenders feel they cannot rely on such forecasts, or that these show a significant short-term deterioration, then this may precipitate an immediate response from them to protect their position.
Note that the ‘cash-strapped’ scenario does not necessarily imply that the organisation needs to be in distress. It could be a function of entrepreneurial or private-equity-backed owners wanting to minimise their cash commitments to a particular investment as they decide how best to allocate their resources across a portfolio of interests.
If they can keep surplus funds in one business to a minimum, that may enable them to take advantage of other investment opportunities elsewhere.
While the board may be relaxed about its cash and liquidity position, there are some situations that will undoubtedly trigger increased scrutiny. The following are some examples, but note that this list is not exhaustive:
It is very difficult to predict when directors will want to assess the group’s liquidity arrangements in greater detail.
Indeed, the level of scrutiny will be partly driven by where the organisation lies on the spectrum between a) having easy access to funds in all circumstances; and b) being severely cash constrained.
Regardless of what prompts the closer scrutiny, there are some essential questions that all corporate treasurers should ask themselves (see below for those).
However, I cannot stress enough the importance of finding the right way to communicate what may be a complex range of outcomes to directors in a way they can easily understand, and which allows them to take the most appropriate decision.
Simplicity and a big-picture approach, rather than a barrage of detail, is likely to be appreciated by most boards.
David Tilston has been CFO of a number of companies, both listed and private-equity backed.
This article was taken from the June 2017 issue of The Treasurer magazine. For more great insights, log in to view the full issue or sign up for eAffiliate membership