Cash flow Forecasting

Why cash forecasting?

A cash forecasting model is an essential tool for treasuer to manage working capital. Forecasting preempt treasurer of

1. Early warning of potential payables in future which resulted in preparing optimal cash reserves early to meet this obligation.
2. Optimize cash buffers. Having information about projected cash inflows allows treasuer 
• To invest the surplus in a reasonable amount
• Reduce the burden of having too much cash 
• Reduce losing an opportunity to invest in higher yielding products (short term).

Source of information to structure cash forecasting

Information is sourced from 2 key areas internally, mainly from treasury and business flow. 

• Treasury: Cash balances (Accuracy depending on getting timely information on accounts eg: MT942 updates, using sweeping/pooling solutions), FX related transactions (eg: forwards, swaps), investments
• Business: Payables, receivables from finance, sales team
• Other sources of information can be retrieved from industry reports from government associations, business magazine or forecast service companies focusing on specific industries.

The accuracy of the forecasting depends on the information feed into the model. For a reasonable degree of accurate forecasting, as much as possible, scheduled items must be included, for example, payroll, monthly bills/expenses & regular receivables.

The impact of different sources & time frame may result in less accuracy in forecasting.

1. Using weekly payment & receivables provide accurate forecasting between 1 to 2 month period
2. Using 3 to 6 months projection, for example using information from industry reports & forecast are less accurate compared to the former
3. Using a budget 0r sales forecast for longer projection

Improving cash forecasting accuracy

Improving its accuracy requires automation and constant feedback and checks on the forecasts. 

1) Automation helps to gather and consolidate different inputs/sources can significantly improve reliability and accuracy. It also helps the treasurer to direct their time and focus on other productive aspects of their work scope. 

However, even with automation, inaccuracy still exists. For example:

Payables & Receivables

Potential problems where invoices are sent/mailed by suppliers and invoices are circulated internally for approval resulting in appearing late compared to the forecast as it is key into account system. This is common in companies with old practices that require a signature on the invoice from management to approve the payments.

As for receivables, companies may issue late invoices if there are no ERP to manage the collections.

Solution: 

A possible solution is to input the invoices into the system first before sending out for approval. Or establishing with suppliers to submit invoices directly into TMS or ERP system. 

For receivables, a possible solution is to use direct debit for prompt collections or automate the generation of invoices and send to customer ERP system directly.

Sales forecasts

Sale team are reluctant to provide detailed forecasts as they do not want to be held accountable

Solution: 

Getting constant feedback from sales and regular reviews with a compensation plan for them.

2) Regular reviews on the forecasts by having regular reviews on the forecast and compare with previous forecasts by having controls to investigate variances from preceding forecast to verify the changes. Matching forecast against a checklist helps to review if anything is missed out. Lastly getting approval from all various department and sources to verify and contribute.

Forecasts should distribute regularly to match periodic of outflows and inflows. Forecasts should also be updated monthly/quarterly/annually to reflect the business cycle and changes.

Summary

1. To create a better cash forecasting tool, it is advisable to establish process and procedures and checklist on the source of information by treasury staff. 
2. Establish the source of information, dates, amount from:
• Payroll dept on schedule payments 
• Payment dept on payments
• Collections dept for receivables
• Treasury or finance on investments, capital expenditures intercompany loans
• Sales forecasts from sales dept based on past history of sales outstanding
• Company expenses
3. Review and apply reasonable views on the sources and draft forecasts
4. Approved and issue the forecast

Treasury Centres, In-house bank and Shared Services Centre. What are the differences?

I received a question asking me what is the difference between Treasury Centre (TC), In-house bank  (IHB) and Shared Services Centre (SSC).

One similarity between TC, IHB and SSC is centralizing in one location. As for the difference, we will understand more if we look into what objectives and activities for each of them.

Treasury Centres (TC)

TC is responsible for managing and strategize its company liquidity by monitoring their cashflows, to decide if require additional capital through borrowings or capital raises. TC is also responsible for managing investment assets, internal processes, FX and making decisions on changes to working capital. 

Roles of TC includes the following below:

1. Cash forecasting
• Measuring the accuracy
• Determine the information sources for the forecast
• Establish controls, policies and procedures of cash forecast
• Automating cash forecasts
2. Cash Management
• To manage the flows (payments and receivables) with objectives on costs savings and effectiveness
• To manage balances with objectives to reduce liquidity & credit risk, cash balances efficiencies
3. Investment Management
• Managing surplus funds not required for operational activities or bank obligations (fees, overdraft)
• Consider the types of investment, strategies, goals and criteria
4. Treasury risk management
• Establish and allow better overall control over group-wide, information and policies on risk management
• Better pricing on FX hedging and better pricing
5. Managing banking relationships
• Negotiate consolidate pricing
• Concentrate on core banks to strengthen the relationship
6. Raising capital
• To raise capital via borrowings or equity issuance
• Working with sell side (bank) to offer company bond and equity offerings
7. Granting of credit
• Manage and establish procedures to grant credit to customers/suppliers to have some control on working capital locked in receivables
8. Maintaining credit rating agencies relationships
1. Treasury responds to credit rating agencies and provides information to maintain their credit rating which will help in getting cheaper debt

In-House Bank (IHB)

IHB is often used and refers as treasury centre as its solutions offer centralized payment flows and balances by executing all flows through the operating companies’ internal multi- currency accounts from 1 location.

IHB is actually a corporate tool for financing purpose using company resources for treasury functions. It is used to execute payment or receivables flows by performing netting on all payments from the group which resulted in savings as fewer payments are executed. 

Cash visibility is improved as balances are maintained in inter-company accounts instead of decentralized individual accounts

As for balances, IHB can leverage balance tools such as cash concentration, notional pooling, interest optimization and managing intercompany loans. Tax needs to be considered as well when executing intercompany loans within the group entities.

Shared Services Centre (SSC)

If IHB is used for execution, SSC is responsible for processing the flows. In my previous post on SSC, it  is centralizing operational & back-office routines such as making payments, collecting receivables, reconciliation, confirming & executing, reporting, 

In transaction banking perspective, its role involves processing payments commonly x-borders payments, reconciliation, FX processing, invoicing etc. My previous post on SSC can be found here.

Summary

In summary, TC is more focusing on the strategies to manage liquidity. IHB is a financing tool employed by TC for cash management and used for execution on behalf of entities. SSC is focusing on processing for payments/collections, reconciliation, operation and backoffice matters.

Shared Service Centres (SSC)

Technologies advancement and corporates looking for solutions to reduce complexity and reduce replicated operations for their business in each geographical area has prompted them to look for Shared Service Centres for answers.

Shared Services Centre (SSC) Vs Outsourcing

1. Is SSC equivalent to Outsourcing? To be exact, outsourced services are provided by an external company while SSC is provided by an internal organizational entity
2. Internal customers of SSC have control in the cost and quality of the service they receive

SSC vs Treasury Centres

1. SSC is actually centralizing operational & back-office routines such as making payments, collecting receivables, reconciliation, confirming & executing, reporting,  Payroll etc.
2. Treasury, on the other hand, manage treasury related matters and strategies such as maximizing deposit returns, loans and risk management using derivatives such as swaps, forwards for hedging
• Treasury also look at debt management by managing debt and establishing control
• Investment management such as using strategies to manage investment i;e: matching strategy, laddering or tranched cash flow allocations
• Interest and equity management
3. SSCs are typically processing on behalf of operating entities, while treasury centres is working more on the importance of managing the working capital and strategies of the corporate
4. SSCs do not need to be tax efficient as they do not process for their own books unlike treasury centres as they are booking transactions in their own books. For example Treasury centres moved their routine payment flows to SSC. SSC will initiate payments from accounts maintained in the treasury centre. These bookings are maintained in TC books instead of SSC as these accounts are held under TC entity name.

What are some considerations required to do to establish a SSC?

1. Talent in the geographical area and labour costs
2. Language and communication
3. Financial infrastructure in that geographical area
4. Ensure internally what operations are to be managed by SSC, what to consolidate and centralize with established best practices to track KPI
5. To invest in training and recognize the importance of employees

What are the benefits for having a SSC?

From: https://www.treasury-management.com/article/4/73/665/a-shared-service-centre-for-treasury-operations.html

Project Ubin Phase 2. Exploring Corda, Hyperledger Fabric and Quorum for RTGS clearing/settlement

There are interesting results and findings from this project to explore using DLT for RTGS settlements. In one of my earlier post, I mentioned that one of the uphill tasks is convincing the banks to participate in Ripple's DLT.

In order for banks to work seamlessly with DLT, banks may have to upgrade or overhaul their existing system. That boils down to what choices to make.

1. Continue to use SWIFT which is already mainstream for x-border payments or 
2. using DLT where there is no concrete proof of concept that it can work or create future unforeseen issues

Project Ubin Phase 2 is using 3 DLT, Corda, Hyperledger Fabric & Quorum for RTGS settlements with focus on funds transfer, queuing and resolving gridlocks. Each of these DLT presents their plus and minus features of the DLT which I will list below shortly after viewing their report from Accenture.

There are more than 1 DLT in the market but seldom I see there are comparisons done for each of them at solving real world problems. The report from this project revealed the findings

In gridlock resolution, Corda uses Cycle solver algorithm developed by themselves and Hyperledger and Quorum uses EAF2 algorithm . The EAF2 algorithm is the earliest FIFO-based algorithm used in Germany.

Corda

Extracted from the report: "Corda is a distributed ledger technology platform designed for use with regulated financial institutions. It is designed for recording, managing and synchronising commercial agreements between known and identified parties at scale without compromising privacy"

Plus points

1. To cater to privacy requirements, Corda shares with banks on need to know basis rather than broad broadcast
2. The funds transfer is able to continue even when there is gridlock resolution running
3. High resiliency as a network can still operates even when some nodes failed
4. New banks integration is easy when  adding a new participating node involves only the installation of the new node itself.

Minus points

1. Its UTXO model requires input states to link 1 or more transactions creating a long chains which makes processing slower as time goes by
2. As single  Notary service (Provides uniqueness and/or validating consensus on received transactions by providing signature to indicate transaction finality.) was used, it introduced a potential single point of failure. If the single notary failed, transactions cannot be completed

Hyperledger Fabric

Extracted from the report: "Hyperledger Fabric is a permission network with the ability to set up private channels between participants where each channel maintains an independent ledger. Channel enables information to be shared between parties on a need-to-know basis."

Plus points

1. As this DLT allows channels for bilateral exchange which are private and having their own ledgers, speed in high when it comes to processing

Minus points

1. Difficult to maintain in future as channels will increase with increase participants
2. New payments are queue if there is gridlock resolution running
3. If orderer (An orderer broadcasts the transactions to all peers in a channel for validation before committing the transaction) fails,it presents a single point of failure to network
4. Requires funding to account for each channel

Quorum

Extracted from the report: "Quorum supports both public and private transactions within the permissioned network. The public transactions are broadcast to all the nodes within the network and are processed like regular Ethereum transactions. The private transactions are sent directly to the specified recipients by Quorum’s privacy service Constellation as encrypted blobs."

Plus points

1. If any Quorum node is disconnected from network, the rest of the network can still function as normal.
2. Supports private and public transactions
3. It sends hashes to all participants and if a participant requires validation of transaction in future, they can confirm with the rest of the network by comparing to hashes that network holds without having to trust their counterparty

Minus points

1. Zero-knowledge proofs generation is slow and consumes computing power
2. New payment instructions submitted is set as 'Inactive' and will not be processed during gridlock resolution processing
3. DAPP orchestrated the settlement transaction and if it fails, entire netting round fails for finality stage

BlockChain solutions for banking

What is the problem?
Current payment processing especially cross border transaction creates a few problems for the banks especially on the management of correspondent relationships, Nostrol accounts maintenance, inefficient settlement process and regulatory issues in today's landscape.

Correspondent relationships
The traditional method for cross border transaction is processed via correspondent banks. Relationships with these banks recently become expensive due to regulatory issues. Blockchain/DLT can solve this problem if all banks in the world join the network.

Interestingly, the recent case between Danske and Deutsche where Deutsche Bank was their correspondent bank used by Danske’s Estonian branch where money flows (euros 2 billion) from Danske are suspicious and whether Deutsche should be held responsible for processing these transactions.

I guess most banks are interested to know the end result of the investigation whether banks should be held accountable for the actions of their correspondent customer and fear if they could be penalized for breaking AML regulations from the actions of their customer's customers.

Nostro accounts
To start x-border transactions processing, each of these accounts are pre-funded with the country's domestic currency which creates an opportunity cost for the banks.

SWIFT DLT proof of concept is working on this to reduce nostro-vostro liquidity. Ripple introduce their own cryptocurrency to solve liquidity issue in NOSTRO accounts as well.

Settlement process
Every MT instruction will move through each correspondent agents based on their technology capabilities, time zone, AML management procedures, reconciliation process to check if funds arrive etc. Furthermore, as instruction passes through each agent, costs increases due to fees impose from each bank and delays in settlements. These create uncertainty in costs.

DLT can resolve this where their technology is able to provide real-time settlement as highlight by Ripple. Of course, provided all banks join the same DLT network.


Ripple Distributed Ledger Technology (DLT)

Ripple is one of the first solution providers which I touched base focusing on enhancing x-border payments processing. Therefore I would want to touch on them below after attending their seminar.

From what I have understood, their objective is to solve these problems which I mentioned earlier by building a real-time gross settlement system for cross border transactions with lower costs, near real-time settlements.

Some of their product solutions are:

RippleNet
one network with all banks participated that forms a network to send and receive payments using their DLT platform with a common set of SLA agreed upon by all participants.

Correspondent relationships can be reduced if most banks participate in this network

X-current
It is their enterprise solution which consists of several modules to act as an RTGS system to facilitate real-time settlements and tracking of payment instructions end to end. The modules include validator, messenger, fx ticker and interledger protocol

Settlement time can be reduced or even in real time with this solution

XRP currency
In my view, XRP currency can resolve the issues of banks parking their funds in different currencies for each domestic country where their Nostro is held thereby creating opportunity costs. By using XRP, banks can allocate less liquidity in domestic currency to process the same volume of cross border payments.

However, using cryptocurrencies invite many questions and debates partly due to the stability of the value with political challenges as well.

xRapid
Its uses their cryptocurrency, XRP to offer financial institutions a reliable liquidity solution to service cross-border payments. Created for liquidity market makers who provide liquidity and exchange between XRP and any other currency so that banks do not need to hold local currency in their NOSTRO accounts.

Final views about DLT solution
DLT is an excellent solution but the major uphill tasks are getting the banks to join these network, going against industry norms as banks are using SWIFT.

SWIFT has already had a roadmap for their GPI to close the gaps surfaced for the past 20 years. However I do not think this is the end of DLT as Singapore has embarked on project ubin to explore the uses of DLT.

Project Ubin Phase 1

It's interesting to read from MAS report about their trial with Ethereum DLT using tokenization SGD currency for payment processing (processing is decoupled from our RTGS system) without creating any monetary inflation in balance sheet bt recategorizing the cash balance to depository receipts.

Tokenization SGD
Before this, digital money exists electronically in stored value cards (Ezlink for example) for retail.
The proof of concept touches on using digital money to process payments instructions with the central bank and its implications.

Money from participants are kept in a collateral account with central bank to reduce credit exposure. Participants are free to convert these digital currencies to fiat anytime as well

How does it works?

1. Notably. a new account(008 account) is created with central bank to serve as an account for collateral
2. Participant sends an top up instruction to MEPS to top up the blockchain account (008 account)
3. Funds will be transfer to 008 via G3
4. MAS will verify the validity of the collateral to proceed with the DR issuance via transaction agent Smart Contract.
5. Participants will exchange value with each other via DLT which is decouple from RTGS system.

Ability to process payments without RTGS
It's interesting to note that payments can continue to process in DLT using tokenize currency which adds on resiliency to processing and decreases the impact of systemic risk in case RTGS system is down.

*Both images are from Deloitte report which can be download from this website. http://www.mas.gov.sg/Singapore-Financial-Centre/Smart-Financial-Centre/Project-Ubin.aspx

Australia New Payments Platform (NPP)

Key takeaways for NPP

1. Operates 24/7 at 365 days
2. Using of ISO20022 format and the use of this format allows sending more remittance information with the payment instruction
3. Initiate payment without account number by using PayId with addressing service
4. Settlement method is not on netting basis and payment gateway of each ADI will send a settlement instruction to FSS for settlement
5. Settles real time within 15 secs via FSS allocation which is be linked to ESA accounts via a sweep to balance positions
6. Extending the access to APP via API

Accessing the platform
There are 5 ways to access the platform

1. As an end user: Businesses, corporates, fintechs, retail individuals, can use NPP to make and receive payments as an orderer and beneficiary
2. As direct participant: Consists of licensed ADI or restricted ADI that connect to the platform for clearing and settlement and meeting the technical requirements Payment Access Gateway
3. As identified institution: Offer their customers real-time data-rich payments via a directly connected NPP Participant who can clear and settle those payments on their behalf. These entities are not required to be ADI or RADI
4. As Overlay services provider: 
• A product or service that uses the NPP’s capabilities in a customized method
• The 1st overlay service is OSKO by BPay
5. As connected institution: 
   1. Connect to the NPP directly by installing an NPP Payment Access Gateway in their own environment in order to be able to send payment initiation and other non-value messages.
   2. Not required to be ADI or RADI as they are not processing or clearing the payments
   3. Able to access the addressing service
   4. These organizations can be payroll providers, share registries, retailers, large corporates,fintechs or organizations like Amazon, Facebook and Google.

API framework for NPP

1. To allow organizations to take advantage of overlay services, NPP released a framework for API development
2. Schema is using JSON for set of HTTP request messages, along with a definition of the structure of response messages
3. Payloads should be designed based on existing ISO 20022 message elements
4. NPPA in collaboration with SWIFT have launched a testing/sandbox environment that will allow fintechs and other third parties to start learning and testing the benefits and capabilities of the NPP using demonstration versions of APIs defined by the NPP API Framework
5. This API sandbox, hosted in the cloud and protected by state-of-the-art security

NPP clearing and settlement process

1. The process described below is summarized. For detailed info, refer to the links I shared below
2. Orderer agent sends a PACS.008 message for clearing
3. Beneficiary agent receives the PACS.008 message, processed and returns back a status file in PACS.002 format
4. Once clearing is completed as described in point 1 and 2, orderer agent will send a PACS.009 message to FSS for settlement unitary after receiving the status message from the beneficiary agent
5. FSS will send a confirmation message to both agents in PACS.002
6. Beneficiary agent will allow the fund to be available to its customer after receiving a positive status message from FSS

Managing liquidity between ESA and FSS accounts

1. NPP allows participants to manage their liquidity by setting upper and lower trigger points to automatically allocate ES Funds to or from the FSS Allocation
2. If FSS falls below the threshold level, RITS will automatically initiate a top-up from the RITS Allocation to restore the FSS Allocation to a Member nominated reset point
3. If the balance in the FSS Allocation rises above the upper threshold,  funds above the reset point will be automatically withdrawn from FSS allocation to ESA
4. Triggering of moving the funds when it hits the threshold levels happens during RITS operating hours
5. If RITS is not operating, funds in ESA will move to FSS allocation
6. RBA offers intraday repurchase agreements (repos), which carry no interest charge but must be reversed later that day, to help institutions manage their outgoing and incoming payment flows through their ESA

Calculation of ESA interest

1. ESA interest is will be calculated on the basis of total EOD balance in ESA accounts, at midnight, seven days a week. 
2. ES Funds in both the RITS Allocation and FSS Allocation will be included in the end of day calculation. 
3. Interest will be paid monthly in arrears on the 1stRITS business day of each month.

1. https://www.rba.gov.au/publications/bulletin/2018/sep/the-new-payments-platform-and-fast-settlement-service.html
2. https://www.rba.gov.au/publications/fsr/2018/apr/box-d.html
3. https://www.nppa.com.au/the-platform/accessing-the-platform/
4. https://www.cuscalpayments.com.au/news/white-papers/using-the-new-payments-platform/
5. https://www.theglobaltreasurer.com/2015/11/26/australias-npp-and-its-impact-on-payments/