Cash Management: Managing Cash Inflows and Outflows

Mike Ablowich of the US Department of the Treasury, Office of Technical Assistance, discussed the managing of cash inflows and Outflows at the 24th Annual ICGFM Conference in Miami Florida. The presentation formed part of the workshop on government cash management.

Mr. Ablowich pointed out that there are accounting and banking controls than can be used. Better control over inflows and outflows enables better cash management.

Accounting controls includes allotments and appropriations. Additional accounting controls include:

• Payment frequency
• On-demand vs. once per week disbursements
• Vendor analysis
• Aggregation of multiple payments to single vendors
• Payment terms

Banking products that are leveraged in the United States are available in other countries:

• Mobile phone banking
  
• Zero balance account to eliminate idle balances
  
• Fraud prevention
  
• Wire transfers
• Automated Clearing House
• Disbursements
• Purchasing and T/E Cards
• Deposits - Paper Checks and reducing fraud through issue file, positive pay & payee name verification
• Armored car/currency
• Lock box
• Credit cards

Mr. Ablowich suggests that developing country governments can advocate these products to banks. The result can be that the private sector in these countries can also make use of the efficiencies associated with these products.

Mr. Ablowich described the advantage of issuing purchasing cards. Purchasing cards reduce controls. Nevertheless, there are numerous advantages for purchasing cards including:

• Simplifies purchasing and payment process
• Responding quickly to disaster problems
• Provide controls by type of expenditure
  
• Lower overall transaction processing costs per purchase
• Increased information for analysis
  
• Reduced paperwork
• Set/control purchasing limits
• Simplify end of year tax reporting
  

Bank reconciliation is a critical part of cash management according to Mr. Ablowich. He advocates daily reconciliation because of the lag between payments and cash balance.

Cash Forecasting from Cash Management Workshop

Mike Ablowich of the US Department of the Treasury, Office of Technical Assistance, discussed government cash forecasting at the 24th Annual ICGFM Conference. Cash forecasting can be used as the basis for evaluating strategic financial policy objectives. He described the entire budget planning and execution lifecycle. He emphasized the importance of cash flow forecasting during budget execution.

Cash flow planning and forecasting synchronizes revenue estimates and spending plans according to Mr. Ablowich. The budget is built in law. But, the budget is different from the authority to spend. This results in a need for a coordinated effort to make sure that resources are available when needed to properly execute the budget and meet the needs of a variety of budget stakeholders. Mr. Ablowich pointed out that cash flow forecasting may or may not be done in conjunction with the process of preparing allotments and apportionments. He pointed out that if a strong system is in place to control spending rates then some cash flow forecasting functions presented are not entirely applicable.

Financial & Treasury Control includes comparing actual cash flows to estimates including asset and liability management to shorten "float." Mr. Ablowich said that preparing cash flow estimates will lead to improvements in the collections and disbursement processes and reduce the cost of funds. He advocates Net Present Value (NPV) analysis even though not all NPV concepts are applicable to the public sector.

Mr. Ablowich addressed liquidity management. He pointed out that liquidity management requires forecasting the cash position to manage maturities and issuance of investments and debt. In other words, "Do I have the right amount of cash when I need it?"

Cash Flow Forecasting Process

The cash flow forecasting process includes selecting forecasting horizons: short term (less than 1 month), medium term (quarterly) and long term (1 year or more). Mr. Ablowich cautions that the longer the forecast horizon, less accurate the forecast. He suggests that it does not make sense to spend time doing a daily forecast for a year from now.

Mr. Ablowich recommended coordinating many participants in cash forecasting such as spending units, central banks, macro-economic planning, treasury and budget.

It is important to remember that the Treasury, according to Mr. Ablowich, in the initial stage of the preparation of a cash flow statement, has to act as an impartial assembler of information to coordinate the preparation of a cash flow forecast. For that reason the forecast must tie back to the budget, otherwise other agencies or stakeholders will believe that the treasury is trying to alter or make judgments about the budget that has already been passed by the legislature. He pointed out that budgets are typically provided on a cash basis, so this should flow nicely into the cash forecast.

Mr. Ablowich recommends using the 80 - 20 rule. He said that this is the most important slide in his presentation to remember. 80% of revenue comes from 20% of the sources. VAT and customs taxes typically represent the 80% of government revenues. Some countries generate significant revenue from resources. Therefore, more time needs to be spent on sources that generate 80% of the revenue.

Cash Forecasting Methodologies

Mr. Ablowich described different cash forecasting methodologies. He described forecasting on afund or agency basis. The choice has to be rational and be supported by the cost/benefit of different planning, collection and forecasting techniques. If a strong I.T. system exists for compiling and synchronizing spending plans then the agency approach might make the most sense according to Mr. Ablowich. If there are three or four major fund groups of equal size then it may make sense to approach this on a fund basis.

Mr. Ablowich described forecasting on an economic or functional basis. Using the economic classification likely lends itself to the easiest forecast to compile and analyze. The functional approach is likely not needed if realistic plans are prepared by agencies on an economic classification basis.

Mr. Ablowich warned that there will always be different degrees of certainty about cash flows. Less predictable cash flow should be considered in risk management, according to Mr. Ablowich. He suggests that payroll represents a certainty for payment. But, large payments on construction projects are less certain.

The types of information sources were discussed by Mr. Ablowich. Integrated Financial Management Information Systems are a data source. The information sources need to be analyzed: cash vs. accrual accounting, treasury single account vs. multiple bank accounts, and methods of budget execution.

Cash Flow Forecasting and Budget Management

Mr. Ablowich discussed revenue forecasting. Budgets should be the source reference. A bad budget will lead to a bad cash flow forecast especially if the revenue estimates are poor from the beginning. The initial budget revenue estimate must be backed by some consistent, corroborating macroeconomic analysis.Weekly or daily estimates of the monthly plan can be prepared using historical daily data lined up against “payment due dates”. Some payments are affected by seasons.

Expenditures can be analyzed based on spending plans and historical trends according to Mr. Ablowich. The past is usually the best predictor of the future in countries with mature financial and budgetary systems. The past can be the best predictor of the future in countries with young financial and budgetary systems if information can be “normalized” for the current year’s situation. He pointed out that governments must be able to predict payroll and pensions payments. He also pointed out looking at the calendar for patterns. For example, standard payments of one source may be made every Friday. Some months have 5 Fridays.

Mr. Ablowich discussed the impact of assets and liabilities on cash forecasting. He introduced how other balance sheet accounts need to be examined for forecasting. He showed spreadsheets from Zambia and Madagascar as examples. He suggested that long-term forecasts require larger teams from throughout the government.

Cash Forecast Variances

There are numerous factors that can be responsible for variances between forecasts and actuals according to Mr. Ablowich. These include:

• Economic growth higher or lower relative to assumptions
• Economic conditions leading to increased borrowing costs or higher investment earnings
• Inflation rates higher than expected leading to higher rates of growth in indexed payments.
• Disasters/Emergency Situations
• Foreign Exchange

Mr. Ablowich pointed out that legal issues can affect cash flow variances including:

• Changes to tax laws by legislature that effect revenue collections.
• Payouts of settlements of court cases.
• Court interpretations of existing tax laws or spending mandates.
• Sharing ratio of taxes between levels of government.

Understanding and Measuring "Float"

Details about understanding and measuring "float" was presented by Mr. Ablowich. He provided clear definitions:

Collection Float

• Mail Float: the delay between the time a check (payment) is mailed and it is received.
• Processing Float: The delay between the time a payment is received and it is deposited.
• Availability Float: The delay between the time a payment is deposited and the time the account is credited.

Disbursements Float

• Mail Float: The delay between the time a check is mailed and the date the check is received.
• Processing Float: The delay between the time the payee receives the check and the time the check is deposited.
• Clearing Float: The delay between the time the check is deposited and the time it is presented to the payor’s bank for payment.

Mr. Ablowich described float analysis in cash management. The purpose of analyzing disbursement and collections float is to shorter this float to as few days as possible. Decreased costs will come in the form of higher interest earnings, avoidance of interest costs and fewer errors in processing. Decreasing process time should also lead to improved internal efficiencies and improved customer service according to Mr. Ablowich. Cutting down the time for funds to go from point A to point B and having information systems tracking this information every step of the way will lead to decreased costs. Shortening disbursement or collections float will likely be the result of using improved banking products or making changes in internal administrative processes.

Float is measured as:

Average Daily Float = Total Dollar Days of Float/Total Calendar Days in Period

Annual Cost of Float = Average Daily Float * Opportunity Cost of Funds

Cash Management Workshop Debt and Investment Policies

Laura Ross from the US Treasury, Office of Technical Assistance described debt and investment policies for proper government debt management. She described how many policy documents are obsolete. Policy documents must not be static.

Ms. Ross explained the importance of tying debt issuances to forecasts. This includes planning matching of service dates to cash forecasts. She described the type of debt vehicles like bonds and notes. She recommended that debt policies should include:

• Issuance Guidelines
• Allowable Investments for Proceeds
• Statements on Projects
• Refinancing
• Glossary of terms

Ms. Ross described the need to also tie investments to forecasts. She recommended benchmarking investments to determine investment priorities. Investments should be secure. She recommended:

• Follow the code of your state or country, then be conservative
• Be very specific in your investment policy on what can and cannot be used (examples on the next few pages)
• Investment policy needs to have oversight
• Constantly monitor information
• Monitor investment report daily
• Should be selected by a committee
• Should understand how the investment works
• Diversify the investment portfolio

Ms. Ross talked about internal and external investment risk. Risk can be mitigated. She described an investment policy should include:

1. Objective – typically safety, liquidity, yield.
2. Roles – who is responsible for investing the funds (ultimately)
3. Investment Monitor
4. Finance Board
5. Ethics and Conflict of Interest
6. Internal Controls
7. Uses for Investment Proceeds
8. Benchmarks
9. Purchasing Investments – Mechanics
10. Allowable Investments
11. Report Components
12. Glossary of terms

Ms. Ross explained the importance of determining how investment revenue should be used. She warned that investment revenue should not be used to reduce taxes. She showed an example of portfolio management.

She recommended the following links for information on debt and investment policies:

Debt Policy Links - Links

• http://www.sykesville.net/minutes/DEBT_POLICY09.pdf
• http://www.arlingtonva.us/Departments/ManagementAndFinance/Bond/PFM%20Response%20to%20Debt.pdf
• http://www.co.hanover.va.us/finance/adopted-04/debt_policy.pdf

Municipal Bond Terms - Links

• http://emuni.com/glossary.php

Investment Policy - Links

• http://www.loudoun.gov/controls/speerio/resources/RenderContent.aspx?data=dafd99cde3184aa2b29943686bf619d0&tabid=326
• http://www.loudoun.gov/
• http://www.arlingtonva.us/departments/Treasurer/files/file71534.pdf
• http://www.nctreasurer.com/dsthome/InvestmentMgmt/GovermentalOpsReports/asset+allocation+overview.htm
• http://www.nystar.state.ny.us/board/assets/sbtif.pdf
• http://www.treasurer.state.md.us/reports/Investment_Policy.pdf

Banking Relations

Laura Ross from the US Department of the Treasury, Office of Technical Assistance, discussed the development of Requests for Proposals for banking services. She warned that RFPs should only be issued when it is needed. There are proper times to create RFPs. You do not need an RFP to ask banks for new proposals on new services.

Step 1 – Document the current environment

The purpose of this step is to understand the current environment for banking services, the key business and technical requirements and identify potential service gaps and improvement opportunities, according to Ms. Ross. This step includes:

• Banking Needs Assessment
• Prepare a customized packet for each area of your treasury organization regarding their current banking services
• Request current bank account analyses for all banks and accounts
• Design a checklist determining necessary information to gather from each function

Step 2 – Develop the RFP

Developing the RFP takes the longest time according to Ms. Ross. Ms. Ross has been on both sides of the banking RFP process. She warns that many RFPs are too large, often include the same question asked five times. The RFP provides a conceptual design of the future banking structure. This step requires:

• Develop an overall vision for banking structure and services required
• Analyze current bank account structures and providers
• Inventory and assess specific concerns and issues for bank service requirements
• Determine list of banks to be included in RFP process
• Develop the customized RFP for those selected banks and issue RFP

Step 3 - RFP Evaluation

Ms. Ross said that the third step focuses on evaluating and prioritizing the bank responses to determine which banks can realistically be considered to move from the current to the target environment. The purpose is to objectively prioritize banks based on their capabilities and responses and to recommended banks identified to participate in bank presentations and visits. She recommends a pre-bid conference. All questions received should be officially answered in writing and provided to all bidders. The evaluation process includes:

• Customize RFP evaluation tool for bank services
• Conduct quantitative analysis of RFP responses
• Score bank RFP results on a weighted basis
• Perform additional technical and qualitative analysis on bank RFPs
• Complete cost analysis on proposed pricing using the estimated volumes
• Determine the short list of banks to participate in the presentation phase

Ms. Ross recommends developing a check list, best on a single page, that ranks the responses. There should be a ranking method. Cost analysis is the most important aspect. She warned that many government RFPs do not provide accurate numbers to enable proper pricing.

Step 4 - Finalist Presentations and On-Site Tours

The fourth step is the research and validation to ensure that the bank can meet the current and future requirements, as stated in their response, at a level of satisfaction to your needs. This step validates the response with the real requirements. Ms. Ross provided explained the process:

• Notify the banks that did not make the final cut
• Contact the short list of banks that made the final cut to let them know of next steps and give them advance notice
• Develop the desired presentation format/script, and provide this to the banks
• Schedule the presentations and bank visits
• Evaluate the demonstrations formally and debrief after each meeting
• Conduct on-site tours of finalist banks as necessary

Ms. Ross suggests getting a list of bank references. She recommends starting at the bottom of the list because the bank will not have time to brief all references.

Step 5 - Bank Selection and Plan Development

The fifth step is the selection of the bank and development of an overall plan which will consider the key tasks, the staffing / skill requirements, timeframes and estimated costs required as next steps to move towards the targeted environment. The process includes selecting the preferred bank(s). Ms. Ross stressd that the implementation plan is the critical step. The result is a documented implementation plan for the conceptual design of the preferred banking structure. She recommends a signed contract.