March 19, 2013Doug Hadden
We’re seeing increased interest in cash management among developing country governments. There are very few Public Financial Management (PFM) ‘best practices’ yet many good practices that are better depending on the country context.
Why is cash management important?
- Governments need to borrow only when needed to minimize government borrowing costs…and to maximize returns on idle cash
- Effective cash management reduces government operational, credit and market risk
- Cash management seeks to reduce spending arrears of the nonpayment by government to suppliers where suppliers react by raising prices higher than they would be otherwise, to compensate for the anticipated late payment by government
- Cash management is necessary because there are mismatches between the timing of payments and the availability of cash
- Government Resource Planning Systems (GRP), often called Government Integrated Financial Management Information Systems (IFMIS), are used to enable cash management
- The purpose of this good practice document is to identify how GRP enables effective cash management
- Effective cash management is enabled through effective budget formulation
What is cash management?
- Government cash management may be defined as “the strategy and associated processes for managing cost-effectively the government’s short term cash flows and cash balances, both within government, and between government and other sectors”.
- Cash flow management includes effective management of government receipts and payments within the government and between the government and nongovernment sectors, as well as the associated account structure and processes to ensure timely processing and reduce unnecessary idle balances.
What are the differences between managing “cash” and “liquidity”
More developed countries make the distinction between cash management as a long-term planning and analysis function and liquidity management to ensure adequate cash is on hand. Short-term investments to ensure that there is effective use of the cash on hand are considered a treasury functionrather than a cash management function exercised through spending ministries.
How are GRP systems used to improve cash management?
- Systems are used to monitor and forecasts cash flow and financing requirements, and performs reconciliation between bank accounts and IFMIS records
- GRP systems support government cash receipt and payment functionality, cash flow forecasting and the management of government cash balances
- GRP systems leverage information and support variance reporting to enable identifying trend patterns.
- The more complex the information, the more there is a need for high-quality information systems. High-performing IT systems are needed to facilitate the preparation and updating of short-term cash projections and the maintaining databases of cash-flow trends. One option is to include a tailor-made cash forecasting module as part of an integrated financial management information system (IFMIS), with the accounting module of the IFMIS would provide data on inflows and outflows.
- Commitment accounting, used in GRP, provides early insight into cash requirements by tracking the commitment cycle of requisitions (soft commitments or pre-encumbrances), purchase orders (hard commitments, obligations or encumbrances), goods receipt and expense vouchers.
- Cash Management requires a mix of purely financial data, garnered from accounting systems and statements of managerial intention.
- In advanced countries, high-quality, timely, and comprehensive data on government cash transactions are usually readily available in the government’s accounting system, which is fully computerized.
What is the Treasury Single Account (TSA)?
A TSA can be defined as a unified structure of government bank accounts enabling consolidation and optimum utilization of government cash resources. It separates transaction- level control from overall cash management. In other words, a TSA is a bank account or a set of linked bank accounts through which the government transacts all its receipts and payments and gets a consolidated view of its cash position at the end of each day.
Why is the TSA critical to effective cash management?
- A country with fragmented government banking arrangements pays for its institutional deficiencies in multiple ways. First, idle cash balances in bank accounts often fail to earn market related remuneration. Second, the government, being unaware of these resources, incurs unnecessary borrowing costs on raising funds to cover a perceived cash shortage
- The TSA helps consolidate government cash balances, gives the ministry of finance/treasury oversight of all government cash flows, and brings improvements in budget control and monitoring.
- The establishment of a TSA significantly reduces the government debt servicing costs, lowers liquidity reserve needs, and helps maximize the return on investments of surplus cash
What problems do developing country governments face when implementing cash management?
- There is significant concern in many governments that fiscal discipline is lost through the use of the TSA. The creation of a single treasury account is a major undertaking for those countries that have traditionally dispersed cash to departments.
- Ministries often fear the lack of control once bank accounts are centralized and there can be significant resistance to the TSA.
- Some information systems used for GRP do not easily enable phased methods of introduction the TSA and cash management processes.
- Some developing countries operate using line item budget controls that add significant burden on Ministries of Finance to handle budget transfers rather than focus on cash management.
- Institutional arrangements within government and with banks present difficulties that often require legal reform to resolve. For example, in some countries the Treasury may lack authority to manage all government bank accounts.
- The lack of integration among Line Ministries and sub-national governments means information on cash availability can be out of date.
- Weak cash forecasting capacity is a common problem in many developing countries.
What is the linkage between cash management and budget execution?
- In many developing countries, government officials misperceive government cash management as synonymous with budget execution, accounting control, or debt management instead of as a practice that aims to manage the government’s cash positions, including their risks, cost-effectively.
- Budget execution is about ensuring that the budget is managed consistently within agreed financial limits… By contrast, cash management is about ensuring that the government has the liquidity to execute its payments. This requires planning ahead. Cutting planned expenditure because of a lack of cash is cash rationing, not cash management. Effective cash management removes the need for cash rationing.
- Cash management should not be considered a budget or accounting control, pre-authorization should replace the pre-funding system.
- The combination of cash flow forecasting and modern payments systems allows for separation between the permission to spend and the provision of cash. It is no longer necessary for spending units’ bank accounts to receive funds before expenditure is authorised.
- However, realistic budget projections and/or conservative revenue projections are helpful for avoiding cash management problems.
- Modern cash management is not concerned with controlling expenditure authorizations so that the timing of cash disbursements matches the timing of cash receipts.
What are the characteristics of a good cash management system?
- Budget: Credible budget formulation to assist cash forecasting
- TSA: Centralization of government cash balances and establishment of a TSA structure
- Payments Processing:Use of modern payments processes are designed to avoid unnecessary use of cash, as well as to reduce operational risk and opportunities for fraud.
- Forecasts of one to five days ahead are essential in a well developed cash management system, which takes account of variances in cash flows that occur during the course of each month.
- Efficient cash management requires the ability to forecast daily cash flows across the TSA (ideally at least three months ahead).
- Ability to make accurate projections of short-term cash inflows and outflows
- Data Integration and Timeliness:
- Institutional and Policy Arrangements:
- Sufficient Human Capacity: human capacityis required to provide good managerial forecasts and effectively leverage information systems
- Short-term borrowing instruments: manage the timing mismatch between inflows and outflows
What are the stages to develop an effective cash management system in developing countries?
The sequencing of cash management functionality in developing country governments differs by context. Sequencing generally follows a pattern similar to this:
Stage 1: Addressing Fundamentals
- Treasury Single Account – the integration of government accounts, and the sweeping of overnight balances into a single account held by the Treasury at the central bank.
- Establishing a cash management unit (CMU).
- Ensuring realistic annual budget projections.
- Avoiding use of physical cash.
- Limiting cash advances.
- Improving government accounting.
Step 2: Forecasting capability
- The development of capability within the Treasury to monitor and forecast flows in and out of governmentsuch as developing cash projection skills.
- Preparing short-term projections of cash flowsand preparing cash plans.
- Establishing information-sharing arrangements.
- Ensuring information exchanges for cash projections takes place.
- Assessing the impact on cash projections of expenditure commitments in the pipeline.
- Processing expenditure approvals and payments efficiently.
- Computerizing expenditure processes.
- Maintaining a minimum cash balances.
- Remunerating idle cash balances.
- Extending TSA coverageand using banking facilities.
- Coordinating cash and debt management.
- Formalizing relations with banks for treasury services.
- Clarifying the relationship between the treasury and the central bank.
Step 4: Rough tuning and fine tuning
- Active cash management is aimed at smoothing out short-term cash balances through actively investing excess cash balances or borrowing in the financial markets to reach the balance target and is a characteristic common in more developed countries.
- All government balances at the central bank should be brought within the targeting process.
- Developing more active policies, drawing on a wider range of instruments or institutional options, to smooth more fully short-term changes in the Treasury’s balance at the central bank.
- Becoming more active in daily management of cash balances.
- Introducing daily bank account “sweeping” arrangements.
- Ensuring the security of short-term placements by the treasury.
- Refining cash flow projectionsand strengthening coordination.
- Issuing T-Bills (or other short-term borrowing instruments) to a pattern deliberately designed to offset the impact on the banking sector of net cash flows in and out of government.
How is cash forecasting accomplished?
- The difficulties of cash forecasting involve not only lack of good internal coordination and administrative structures, but also additional problems such as poor advance information on loan or grant disbursements.
- Through adequate historical data for projecting all inflows and outflows from the TSA (revenue remittances, payments for expenditures, debt transactions, etc.).
- Through a comprehensive framework that includes all inflows of government cash resources and provides a framework for planning the payment of short- and long-term cash liabilities when they fall due. This requires budget information management systems that are comprehensive, with data that are timely, accurate, and reliable.
- Through consistency with annual budget projections. The starting point for in-year cash plans is the cash needed to implement the annual budget adopted by Parliament.
- By concentrating on the major inflows and outflows. The focus should be on ensuring that the projections for the major taxes and other revenues, and for the most important expenditures, are as realistic as possible. The projections of small revenues and expenditures can be assumed to follow a simple pattern.
- By identifying past patterns for particular inflowsand outflows and identifying the timing of the major flows.
- Through ascertaining cash needs from expenditure commitments. Ministries and agencies are best placed to project trends in their expenditures (and revenues they collect).
- By the separation between the permission to spend and making actual cash payments means that flows through the TSA must be the focus of the forecast.
How can GRP systems improve cash management?
- GRP systems enable progressive activation enabling governments to sequence cash management functionality
- Support for electronic funds transfer and integration among ministries provides up-to-date liquidity information
- GRP systems support the migration to the TSA and numerous TSA methods
- Comprehensive transactional information enables the development of cash requirements, cash flow and aging reports
- Historical informationin GRP systems enable creating credible budgets using spending trend analysis
- Through the use of commitment accounting, GRP systems track the entire procurement cycle from requisitions enabling improved prediction of cash requirements
- Budget and commitmentcontrols can include warrants, or authorization to spend, over short periods of time based on cash forecasts
- Cash controlscan set thresholds to limit spending should there be reduced liquidity
- Workflowprocesses in GRP systems enable governments to adjust for temporary cash problems and alerts decision-makers on potential liquidity problems
What is a good practice approach to using GRP for good cash management?
- GRP software supports the use of the Treasury Single Account.
- GRP software provides the historical information necessary to make effective cash forecasting.
- GRP software provides budget planning and budget execution functionality to ensure creating credible budgets, managing against the budget and adjusting for cash availability.
- GRP software provides integration among revenue and expenditure systems including payment systems.
- GRP software can eliminate the poor practice of cash box budgeting.