Direct or indirect method: which should you choose ?
During a conference of treasurers and CFOs, David Brault, Managing Partner at Objectif Cash and a partner of ACA, interviewed Clément Letourneux about how he views the roles and responsibilities of a treasurer, a position that Letourneux occupied for two decades in different contexts (medium-sized enterprises, large corporations).
This section of the interview focuses on methods for making cash flow projections and the roles of the treasurer and the CFO in this regard, as well as their different viewpoints.
David Brault: In two decades of working in cash management, you went through financial crises, as well as structural and organisational changes at companies. In regards to making cash flow projections, what is your viewpoint? Who has ‘ownership’ within the company? Every CFO and every treasurer has their own way of doing things, which can sometimes result in projections that are off by several million! Is there a preferred method?
Clément Letourneux: There are two main, complementary methods for preparing cash flow projections. The method you should prioritise depends on the company’s financial situation. Everything depends on the company’s financial situation: whether the company is having cash flow problems or if it finds itself in a cash-rich situation.
- The cash-flow direct method
This method focuses on short-term cash inflows and outflows. Sometimes you have to go find paper invoices before they’re even entered to get the company’s most up-to-date cash position: Where will we be tomorrow? Next week? Will I be able to make payroll? etc. Companies often use this method and, in fact, it’s the most natural and intuitive method. In particular, in a difficult cash flow situation, it helps you take ‘emergency’ decisions about what to prioritise.
However, you have to look further ahead than just one month! That’s where the direct method has its limits. As such, you have to couple it with the indirect method.
- The indirect method
The indirect method gives you the medium-term view of cash flow that you need to make projections. In that case, you work off of the financial year budget with the people in charge of budgeting: management auditors and operations staff responsible for their own budgets. This work is then connected with the direct method. Of course, this requires teamwork, and not just a quick meeting! If you want to develop a more fine-tuned, higher-quality understanding with better predictions, you have to analyse the right mechanisms and understand the company’s true cash flow cycles. As such, you have to dissect the information and get into the details. This involves taking a broader look at things and monitoring ratios to see if results are consistent with initial assumptions.
- Systematising the cash flow projection process
In practical terms, you have to have data from both accounting and management auditing. Truth be told, you have to spend time seeking out information. The ideal situation is to automate processes using a tool: the management auditing people establish a budget for the financial year and it is imported into the software, which then processes everything and produces cash flow projections using the direct or indirect method! That’s the ideal situation. In my experience, companies often have good management tools that produce financial reports at least including EBITDA or net income, which allow you to consolidate management controls for each BU. However, these tools lack a cash flow component. As such, you need to organise your company to establish best practices so that the EPM tool incorporates cash flow projections.
- When the treasurer goes to war!
In my experience, you sometimes have to put up a fight to get the budget you need to have the resources, tools, and organisation that allow you to deliver added value for cash management! You need to quickly convince top management that the company needs to adopt the right tools which, once in place, will be able to provide effective warnings and prevent crises.
Indeed, when your company is having cash flow problems, you can make cash flow projections and say WHEN the company will hit a wall, but it’s too late to perform financial optimisation. In that case, it’s too late because the banks will no longer have confidence in the company. Instead, if you anticipate these things, you can change the course of events. As such, you need to establish phases for your projects, pick your battles, and be able to coordinate the entire digitisation process.
No matter the method you use, the important thing is that the entire company needs to think about cash management! With these kinds of projects, the treasurer plays a decisive role and the CFO is a key sponsor.
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