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Cash Flow Exposure Management Begs for Improvement

The nature of a treasury function is different from that of a manufacturer's operations group. Treasury and finance have more dependence on information systems, and staff activities are generally less structured than in factory work. However, treasury and finance certainly have processes that can be improved to deliver better outcomes using fewer resources.

Lean principles can help treasury and finance teams to streamline FX risk forecasting, in particular, by:

• Reducing cycle time. Lean principles help a treasury organization create a clear workflow by identifying steps in the process that can be optimized and automated.
• Eliminating waste. A Lean approach enables a treasury function to identify areas that generally succumb to manual error, reduce reliance on institutional knowledge, and eradicate time wasted on manually collecting and consolidating forecasts.
• Infusing transparency. Lean can also make it easier to detect data-entry mistakes through data quality checks, variance analysis, and cell-level annotations.

The process of forecasting the FX exposures of a company's upcoming cash flows tends to be highly manual and not very standardized. Thus, this process is a great candidate for improvement under the guiding principles of Lean.

Companies looking to apply Lean principles to cash flow exposure forecasting need to analyze every part of the process in order to maximize the value delivered and minimize waste. They need to start by examining how they create and manage the baseline forecast, progress through understanding and trusting the exposure collection and consolidation processes, and end with production of the exposure analysis and management of the hedging strategy and decision process. Only by tackling the end-to-end workflow will an organization drive out errors and eliminate waste, minimize cycle time, and increase transparency and trust in the process and in the results.

Lean principles can clarify and streamline FX cash flow exposure forecasting by providing a framework for developing:

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1. A clear workflow

Lean practitioners believe waste comes from having unnecessary steps in the production process; simplifying the workflow plays a large role in process improvement. A treasury team that is taking a Lean approach to FX risk management should evaluate all the related processes, from data entry in the field to the initiation of hedges to mitigate known risks.

Technology can help treasury teams eliminate process friction and improve their productivity, providing more time to build strategic, educated forecasts. We particularly recommend using an automated process that prioritizes forecast initiation through the distribution of a pre-populated baseline which provides a version of the previous forecast, ensuring that everyone in the field is starting the process from the same, single version of the truth. Such an approach can prevent errors from previous forecasts from transferring over, as any changes made by reviewers are copied over to the new forecast, and can reduce the amount of time needed to begin forecasting.

However, it's essential to improve processes from end to end. Simply automating one part of the cash flow exposure forecasting process does not eliminate the waste and potential for errors that may be associated with another step. For example, many treasurers have invested in the latest technology to facilitate trade recommendations, but many of the processes leading up to that step are still manual and completed in spreadsheets. As a result, treasury teams still struggle to implement a consistent hedging strategy because they lack confidence in the data they're using to make decisions.

To determine whether their workflow is effective, treasurers should evaluate the timeliness of the forecast, the accuracy of submitted cash flows, the level of analysis around exposures, and the impact of resulting hedging actions on overall results. Once forecasts are submitted, the workflow should involve proper review with appropriate approval processes. In addition, the treasury team should have a clearly defined exposure-analysis methodology for evaluating the quality of submitted cash flow exposures. Once the review and approvals are complete, the workflow should follow corporate FX policy so that the team can come to appropriate decisions for mitigating the risk.

It is important for the treasury team to take any steps necessary to improve the forecast generation and submission process, so that they can make sure all teams are providing high-quality cash flow forecasts and doing so in a timely manner. It's also important to keep in mind that transparency is crucial at every step in the workflow.

Manufacturing plants that have Lean operations allow for the entire process to be witnessed, end to end, from any place on the factory floor. The same philosophy can be applied to the FX exposure management process in order to achieve maximum visibility into underlying data and to allow for continuous improvement. To provide transparency, companies should track all changes made to exposure data, from forecast initiation all the way to trade execution. They should report on the exact nature of every change, including the individual who made it, the exact time of the change, the reason for the change, and the authorization for the change.

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2. Forecast capture and consolidation

In many companies, people in the field submit information for the corporate cash flow exposure forecast in different formats, through different mediums and at different times. Treasury teams often find it difficult to keep track of hundreds of spreadsheets, fix formatting issues, standardize categories, and consolidate all the submitted forecasts to create one master forecast. Collecting and compiling data manually is time-consuming and can be confusing, leaving room for process error and its associated risk.

Documenting the process in its current state shows a treasury team where inefficiencies lie, and helps managers map out the desired future state of their process. For companies that manually capture and consolidate cash flow exposures, a Lean analysis of workflows may reveal that a centralized exposure forecasting platform would simultaneously reduce the risk of errors and the amount of time treasury spends collecting and consolidating individual forecasts.

To drive a more efficient and timely cash flow exposure forecasting process, treasury may look to automate any steps that add value. Automation in the collection and consolidation stage creates a bridge between the teams who put together individual forecasts and the processor who consolidates them into a master forecast. It facilitates collaboration within the finance team, which gives more time back to field finance and results in a more accurate forecast.

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3. Cash flow exposure analysis

Treasury teams should also follow a well-defined exposure analysis workflow. The process should include analyses of aggregated exposure, outstanding hedges, and resulting currency actions. It should also list out the specific situations that would require extra attention, such as new currency relationships or exposure categories. Finally, the process should outline how to review data for near-term cash flows and for cash flows that are still three or four quarters out. Defining these prioritizations enables the team to focus on the periods that are most relevant, which creates efficiency.

In organizations that do not use a particular format or structure to aggregate data, treasury teams waste a lot of time trying to force data submissions into a usable format. Dictating a standard format for exposure analysis and review gives treasury more time to trap quality issues at the source and drives forecast team collaboration, ultimately providing better insight into exposures.

Treasury should also use variance analysis, and should build a measurement-based approach that lets them focus on reducing errors and producing better results. Variance analysis allows the treasury team to identify significant movements in forecasts for additional investigation and verification. The process is further improved if the variance analysis includes detailed information on the differences in exposures that submitters and reviewers can refer to when analyzing the data.

The exposure analysis and review process should automatically flag variances above a certain threshold, ensuring that only the highest-quality exposure data is aggregated and used to make hedging decisions. This step eliminates currency surprises, protecting cash flows more confidently with better data and infusing transparency into the forecasts.

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The Bottom Line

The challenge of accurately forecasting cash flow exposures is not unlike the challenges facing many manufacturers; operations groups in manufacturing and finance functions both deal with isolated and largely manual processes that rely on the ability of everyone in the supply chain to deliver the end product.

As was the case for Toyota, treasury has the opportunity to take a Lean approach to cash flow exposure forecasting, to help ensure that the process is streamlined, wasted time and effort are reduced, and errors are eliminated. By eradicating manual processes that do not have a direct bearing on the value of the exposure forecast, and may even lead to inaccurate forecasts, a Lean approach improves the quality of data and yields a more efficient process, enabling better risk management.

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Fikre Bizuneh is the director of risk analysis for FiREapps. He has more than 13 years of experience in FX exposure management, workflow design, treasury systems integration, and process improvements. Prior to joining FiREapps, Bizuneh oversaw both balance sheet and cash flow FX exposure management programs at Alcatel-Lucent and Lucent Technologies.

Malcolm Cummings, managing director of product management, helped establish the FiREapps product management group. Most recently, he oversaw the development and launch of the newly introduced FIREapps for Cash Flow solution. Prior to joining FiREapps, Cummings worked for two decades in executive roles with Deutsche Bank, E.On Energy Trading, and other organizations.