King Arthur could call on Merlin to forecast Camelot’s cash-flow problems. But absent a reliable soothsayer, corporate treasurers will have to rely on cash-flow models to predict the future of corporate capital.
One option is the Cash Flow at Risk (C-far) volatility model, developed by New Yorkbased National Economic Research Associates (NERA). Designed to help companies determine the probability of severe shocks to cash flow and to ascertain capital adequacy, the model creates a universe of corporate risk derived from market capitalization, earnings to assets, industry risk, and stock price volatility. Since NERA launched C-far six months ago, there has been “substantial interest” from several Fortune 500 CFOs, notes Louis Guth, NERA’s senior vice president.
“The development of the C-far product fills a gaping hole in the quantification of risks, because it moves beyond the financial and commodity risks that can be modeled with existing VaR [Value at Risk] technology,” says Art Roos, vice president and treasurer of Niagara Mohawk Holdings Inc., a Syracuse, N.Y., energy company that is currently evaluating C-far.
Ethan Berman, CEO of RiskMetrics, another provider of risk- measurement tools, says that the cash-flow-at-risk concept is almost a decade old, noting that the company’s one-time parent, J.P. Morgan, pioneered the commercial use of VaR models in the early 1990s. According to Berman, more than 50 corporations currently use RiskMetrics’s quantitative tool.
“We’ve used RiskMetrics for four or five years, so it is relatively new for us, but then it’s relatively new for most companies,” explains a treasury representative for consumer-products giant Procter & Gamble Co. who declined to be identified. He notes that although the company is “pleased with the tools we use today, P&G executives continue to support the evaluation of new approaches to assess risk.”
But just how big is the corporate appetite for newer models? “There is a misunderstanding among CFOs that additional risk measurements will drive away existing shareholders and encourage people to sell, when this is not the case,” says Guth. Companies with volatile results are penalized in the marketplace by stock- and bondholders, contends Berman. “But the more transparency a company can provide, the higher the company will be valued by all constituencies.”