Foreignexchange (FX) is a growing concern for more than 50 percent ofcompanies around the globe. That's why an increasing number ofbusinesses are now incorporating process improvement practices—suchas Lean, Six Sigma, and kaizen—into their financial risk managementprocesses.

These methodologies, now widely used in all kinds of businesses,were originally used by manufacturers, most notably Toyota. TheToyota Production System (TPS) popularized the idea of taking astrategic approach to managing manufacturing operations with thegoal of saving time and money. A flow of production based on HenryFord's assembly line, the TPS model helped Toyota make majorstrides in productivity and propelled the company into the globalmarket. Other corporations began to follow suit and apply theprinciples to their own businesses. Ultimately, the TPSphilosophies influenced development of the modern principles of SixSigma and Lean production.

Lean processes are not exclusive to manufacturing. In fact, Leanconcepts have spread across many disparate industries andorganizations, such as Target Corp., Sysco, Sempra Energy, andCitigroup. Operational groups in these organizations (and manyothers) use Lean principles to increase efficiency and eliminateerrors and wasteful practices.

Lean concepts have been growing in popularity within financefunctions as well. Like every organization, a finance team needs tooptimize the accuracy and efficiency of its processes. Plus,finance is known for being methodical and disciplined—at times thefinance department is seen as an information factory—so a Leanapproach to process improvement is often a good fit. In somecompanies, the Lean philosophy has extended into treasury,particularly to reducing the time and effort involved in managingforeign exchange (FX) risk.

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Cash Flow Exposure Management Begs forImprovement

The nature of a treasury function is different from that of amanufacturer's operations group. Treasury and finance have moredependence on information systems, and staff activities aregenerally less structured than in factory work. However, treasuryand finance certainly have processes that can be improved todeliver better outcomes using fewer resources.

Lean principles can help treasury and finance teams tostreamline FX risk forecasting, in particular, by:

• Reducing cycle time. Lean principles help atreasury organization create a clear workflow by identifying stepsin the process that can be optimized and automated.
• Eliminating waste. A Lean approach enables atreasury function to identify areas that generally succumb tomanual error, reduce reliance on institutional knowledge, anderadicate time wasted on manually collecting and consolidatingforecasts.
• Infusing transparency. Lean can also make iteasier to detect data-entry mistakes through data quality checks,variance analysis, and cell-level annotations.

The process of forecasting the FX exposures of a company'supcoming cash flows tends to be highly manual and not verystandardized. Thus, this process is a great candidate forimprovement under the guiding principles of Lean.

Companies looking to apply Lean principles tocash flow exposure forecasting need to analyze every part of theprocess in order to maximize the value delivered and minimizewaste. They need to start by examining how they create and managethe baseline forecast, progress through understanding and trustingthe exposure collection and consolidation processes, and end withproduction of the exposure analysis and management of the hedgingstrategy and decision process. Only by tackling the end-to-endworkflow will an organization drive out errors and eliminate waste,minimize cycle time, and increase transparency and trust in theprocess and in the results.

Lean principles can clarify and streamline FX cash flow exposureforecasting by providing a framework for developing:

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1. A clear workflow

Lean practitioners believe waste comes from having unnecessarysteps in the production process; simplifying the workflow plays alarge role in process improvement. A treasury team that is taking aLean approach to FX risk management should evaluate all the relatedprocesses, from data entry in the field to the initiation of hedgesto mitigate known risks.

Technology can help treasury teams eliminate process frictionand improve their productivity, providing more time to buildstrategic, educated forecasts. We particularly recommend using anautomated process that prioritizes forecast initiation through thedistribution of a pre-populated baseline which provides a versionof the previous forecast, ensuring that everyone in the field isstarting the process from the same, single version of the truth.Such an approach can prevent errors from previous forecasts fromtransferring over, as any changes made by reviewers are copied overto the new forecast, and can reduce the amount of time needed tobegin forecasting.

However, it's essential to improve processes from end to end.Simply automating one part of the cash flow exposure forecastingprocess does not eliminate the waste and potential for errors thatmay be associated with another step. For example, many treasurershave invested in the latest technology to facilitate traderecommendations, but many of the processes leading up to that stepare still manual and completed in spreadsheets. As a result,treasury teams still struggle to implement a consistent hedgingstrategy because they lack confidence in the data they're using tomake decisions.

To determine whether theirworkflow is effective, treasurers should evaluate the timeliness ofthe forecast, the accuracy of submitted cash flows, the level ofanalysis around exposures, and the impact of resulting hedgingactions on overall results. Once forecasts are submitted, theworkflow should involve proper review with appropriate approvalprocesses. In addition, the treasury team should have a clearlydefined exposure-analysis methodology for evaluating the quality ofsubmitted cash flow exposures. Once the review and approvals arecomplete, the workflow should follow corporate FX policy so thatthe team can come to appropriate decisions for mitigating therisk.

It is important for the treasury team to take any stepsnecessary to improve the forecast generation and submissionprocess, so that they can make sure all teams are providinghigh-quality cash flow forecasts and doing so in a timely manner.It's also important to keep in mind that transparency is crucial atevery step in the workflow.

Manufacturing plants that have Lean operations allow for theentire process to be witnessed, end to end, from any place on thefactory floor. The same philosophy can be applied to the FXexposure management process in order to achieve maximum visibilityinto underlying data and to allow for continuous improvement. Toprovide transparency, companies should track all changes made toexposure data, from forecast initiation all the way to tradeexecution. They should report on the exact nature of every change,including the individual who made it, the exact time of the change,the reason for the change, and the authorization for thechange.

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2. Forecast capture and consolidation

In many companies, people in the field submit information forthe corporate cash flow exposure forecast in different formats,through different mediums and at different times. Treasury teamsoften find it difficult to keep track of hundreds of spreadsheets,fix formatting issues, standardize categories, and consolidate allthe submitted forecasts to create one master forecast. Collectingand compiling data manually is time-consuming and can be confusing,leaving room for process error and its associated risk.

Documenting the process in its current state shows a treasuryteam where inefficiencies lie, and helps managers map out thedesired future state of their process. For companies that manuallycapture and consolidate cash flow exposures, a Lean analysis ofworkflows may reveal that a centralized exposure forecastingplatform would simultaneously reduce the risk of errors and theamount of time treasury spends collecting and consolidatingindividual forecasts.

To drive a more efficient and timely cash flow exposureforecasting process, treasury may look to automate any steps thatadd value. Automation in the collection and consolidation stagecreates a bridge between the teams who put together individualforecasts and the processor who consolidates them into a masterforecast. It facilitates collaboration within the finance team,which gives more time back to field finance and results in a moreaccurate forecast.

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3. Cash flow exposure analysis

Treasury teams should also follow a well-defined exposureanalysis workflow. The process should include analyses ofaggregated exposure, outstanding hedges, and resulting currencyactions. It should also list out the specific situations that wouldrequire extra attention, such as new currency relationships orexposure categories. Finally, the process should outline how toreview data for near-term cash flows and for cash flows that arestill three or four quarters out. Defining these prioritizationsenables the team to focus on the periods that are most relevant,which creates efficiency.

In organizations that do not use a particular format orstructure to aggregate data, treasury teams waste a lot of timetrying to force data submissions into a usable format. Dictating astandard format for exposure analysis and review gives treasurymore time to trap quality issues at the source and drives forecastteam collaboration, ultimately providing better insight intoexposures.

Treasury should also use variance analysis, and should build ameasurement-based approach that lets them focus on reducing errorsand producing better results. Variance analysis allows the treasuryteam to identify significant movements in forecasts for additionalinvestigation and verification. The process is further improved ifthe variance analysis includes detailed information on thedifferences in exposures that submitters and reviewers can refer towhen analyzing the data.

The exposure analysis and review process should automaticallyflag variances above a certain threshold, ensuring that only thehighest-quality exposure data is aggregated and used to makehedging decisions. This step eliminates currency surprises,protecting cash flows more confidently with better data andinfusing transparency into the forecasts.

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The BottomLine

The challenge of accurately forecasting cash flow exposures isnot unlike the challenges facing many manufacturers; operationsgroups in manufacturing and finance functions both deal withisolated and largely manual processes that rely on the ability ofeveryone in the supply chain to deliver the end product.

As was the case for Toyota, treasury has the opportunity to takea Lean approach to cash flow exposure forecasting, to help ensurethat the process is streamlined, wasted time and effort arereduced, and errors are eliminated. By eradicating manual processesthat do not have a direct bearing on the value of the exposureforecast, and may even lead to inaccurate forecasts, a Leanapproach improves the quality of data and yields a more efficientprocess, enabling better risk management.

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Fikre Bizuneh is the director ofrisk analysis for FiREapps. He has more than 13 years of experiencein FX exposure management, workflow design, treasury systemsintegration, and process improvements. Prior to joining FiREapps,Bizuneh oversaw both balance sheet and cash flow FX exposuremanagement programs at Alcatel-Lucent and LucentTechnologies.

Malcolm Cummings, managing director ofproduct management, helped establish the FiREapps productmanagement group. Most recently, he oversaw the development andlaunch of the newly introduced FIREapps for Cash Flow solution.Prior to joining FiREapps, Cummings worked for two decades inexecutive roles with Deutsche Bank, E.On Energy Trading, and otherorganizations.