Managing a company with volatile cash flows presents unique challenges for treasurers. With market conditions increasingly uncertain and difficult to predict, the ability of treasury to react to events will raise expectations of the department even further both within and outside the organization. This means treasury’s importance and strategic role will continue to be elevated.     

There are three key principles that treasury must consider when managing a company with volatile cash flows.

Financial discipline

The financial strategy should cover, for example, when is it acceptable for the company not to live within its means, when dividends can be funded with debt, etc. Generally, under adverse market conditions only use cash (and not debt) to fund share buybacks and dividends.

Do not over-gear the balance sheet in good times (strong cash generation and low gearing), based on an expectation that trading and market conditions will remain positive. Also, do not rely on asset disposals to be done quickly or to restore financial flexibility in adverse market conditions. Lastly, do not increase dividends aggressively in good times or commit to a progressive dividend policy off a high base as a downturn could lead to a payout ratio that is not sustainable.

Funding

The more volatile and cyclical the cash flows, the more predictable the sources of capital should be. This is accomplished by having:

• A credit rating that is stable and preferably at least investment grade
• A sufficiently large committed revolving credit facility supported by a strong group of banks
• Access to diversified funding in terms of source, maturity and currency.

It’s not a good idea to use a revolving credit facility or commercial paper as permanent funding, as they must be used to fund cyclical cash flows.

Up-to-date financing documentation and a strong market awareness enables a company to successfully capitalize on windows of investor confidence and secure finance on attractive terms.

Risk management

• Ensure that company policy is breached before a loan covenant is breached.
• Loan facility terms and conditions (e.g. covenants, waivers) must ensure the cyclical nature of the business is taken into account.
• Refinancing risk limits (debt maturities) must also take into account the amount that can be refinanced in adverse market conditions and not only in the best market conditions.
• Manage rating agency relationships proactively to ensure no surprises.
• Develop comprehensive downside scenarios and action plans to manage them should they eventuate.
• Robust financial planning processes are essential even though cash flows may be unpredictable.

Riaan Bartlett, CTP, is a treasury and finance executive based in Pretoria, South Africa.