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com
Opportunity Cost Risk Questionnaire

What is Opportunity Cost Risk?
Opportunity cost risk is the risk that a better opportunity may present itself after an irreversible decision
has been made. In a financial context, opportunity cost is often articulated in terms of the time value of
money, and can be defined as the failure to use cash in an economically efficient way. Opportunity cost
risk arises when governments, businesses or consumers are exposed to economic inefficiencies resulting
in lost or foregone economic value.
The use of funds in a manner that leads to the loss of economic value includes:
Time value losses due to delays in invoicing, order processing, collections, claim processing,
investment of funds, etc. The consequences of these delays could result in some subsidiaries
borrowing while others are investing.
Transaction costs due to inappropriate or inefficient management of cash flows. For example, the
need to borrow high-cost funds or sell securities at a loss, because of the failure to match the
maturities of short-term investments to settlement dates on operational or financial obligations.
Indifference to yield-enhancement strategies and ineffective yield-curve management. Earnings
exposure may exist when funds are invested in a manner that does not generate sufficient returns
to cover costs, profits and risk. Investment losses may result from the failure to obtain return,
which compensates for the degree of risk which is incurred.
Loss of value may also occur when cash moves through the financial system and/or is transferred across
borders.
Economists use the term "opportunity cost" to describe the invisible loss that comes from missing out on a
chance to generate a higher return. As expressed above, the biggest problem businesses face is time
value loss. For instance, assume a company invested its money in bonds at a 6% interest rate. If it was
found later that the money could have been invested in mutual funds with a 10% return, then the
opportunity cost would be 4%.
Business Risks Related to Opportunity Cost
Failure to manage opportunity cost risk can have the following impact:
Loss of foregone economic funds
Time value losses
High or additional transaction costs
Earnings exposure
Declining sales or profits
Competitive position may erode over time
Exposure to an income loss
Missed business opportunities
Root Causes of Opportunity Cost Risk
Sourcing the root causes requires an analysis of the key business processes that influence the cash-to-
cash cycle. Analysis of business processes can be comprehensive or selective depending on
management's view of where the risks and opportunities for improvement are. When analyzing business

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processes, look for areas where cash flow is delayed, funds are left idle or cash transfer and handling
costs are excessive. For example:
Payment float What is happening within the processes that may slow down payments from
customers?
Order entry and processing How long does it take to process and fulfill a customer's order?
Can cycle time be shortened through reengineering, either product design or the order fulfillment
process?
Invoice processing Is there "invoicing float" (i.e., the delay between the date of sale and the
invoicing date)? Is there evidence that customers are "misinterpreting" or exploiting terms such as
"1%/10 net 30" if the company takes six days to issue the invoice?
Receivables management How does the company's receivables management performance
compare with other companies within and outside the industry? If there is a performance gap,
does the company know why?
Payment terms Do operations people understand and consider time value of money
considerations when constructing credit terms to optimize sales and cash flow?
Collection practices Are collections being managed efficiently? For example, would Electronic
Funds Transfers (EFT) or locally available financial instruments speed up the process? Are all
local operations using the most efficient vehicles to collect and process cash receipts?
Discount acceptance Do the discounts offered to customers make economic sense? If they
provide no real economic incentives to customers, should they be reevaluated?
Idle balances Are there significant cash surpluses sitting idle? If so, why?
Cash flow forecasting How effective is the forecasting process, both at the local level and on
a global basis?
Bank charges Are there delays in cash collections from direct debits or other non-check
payments? Is the company being charged for services not utilized or requested? Are bank errors
being detected and corrected as a result of the reconciliation process? How do bank charges
compare to other units?
Foreign exchange What are the exposures on cross-border receivables and payables? Given
historical volatility and market expectations, how do these risks compare with the costs of
hedging?
Relationship issues Does each subsidiary deal with its own bank? Would operating
management be willing to change banks, or would their bank be willing to zero bank accounts to
a domestic cash pool with another bank or to an international cash pool? How sophisticated are
the local banks? Can they efficiently transfer funds out of the country?
Cash transfers and payments Is the company disbursing cash too soon? Is it using the least
costly transfer mechanism? What are the fees charged by banks to process cash transfers?
Investment practices and short-term borrowings Are yields being maximized?
Management Practices and Performance Measures
Zero Cash Management
In today's financial environment, zero cash management is not only possible; it can be an efficient
management tool to mitigate opportunity cost risks. A few years ago, the idea of operating with no cash
would have been considered unrealistic. It was thought that a firm needed precautionary cash balances to
level the peaks and valleys of collections and payments, to protect against emergencies or anticipate
investment opportunities. Today, many financial and technological innovations make carrying
precautionary cash balances a sign of inefficient management. It is actually counter to the interests of the

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company and its stockholders. These innovations include modern payment forecasting models, zero
balance accounts (ZBAs), electronic data interchange (EDI), reduction in the use of bank float and flexible
money markets. In addition, operating with zero cash requires good relations with lenders.
Another issue essential to operating successfully with zero cash balances is accurate cash forecasts.
Select Core Cash Management Banking Partners
Service has replaced price as the determining factor for selecting a cash management bank. Since many
of today's cash management banks have reached comparable levels of technological competence,
reliable, high-quality service is the benchmark companies now use to select banking partners. Today
companies consolidate their accounts and use fewer banks. They partner with these select few banks to
explore innovative ways to streamline and automate processes, to improve information flow and to lower
costs.
Further, as banks consolidate and specialization increases, traditional banks will no longer exist. A
company will find it essential to identify a core group of banks that excel in those services and products
most important to the company's cash management needs. Opportunities and benefits will be:
Lower bank charges
Improved control and access to better interest rates
More leverage when negotiating with banks while avoiding dependency on any single bank
Greater access to new cash management products and services as well as continuous
improvement of existing ones
Lower account reconciliation costs
Develop Accurate Cash Forecasting Models
Because cash flows are neither certain nor synchronized, companies turn to forecasts to reduce
uncertainties. Some businesses use forecasts to look for cash surpluses so that they can decide how
much and for how long to invest excess cash. Other businesses use them to foresee cash shortfalls so
they can plan how much and when to borrow. Specifically, cash forecasts help determine:
Frequency of funds transfers
Amount of funds needed
Company's ability to prepay debt
Foreign exchange and hedging strategy
Short-term investment strategy
Annual cash forecasts help a company set its annual borrowing or investing program. Forecasts also
measure a company's ability to meet short-term debt obligations. Short-term cash forecasts are based on
anticipated receipts and disbursements. From developing an accurate cash-forecasting model,
companies will gain:
Increased effectiveness of the treasury organization
Lessened risk of overfunding payables and of excess balances
Greater access to funds when needed to sustain operations or expand the business
Questions to Consider
1. Are there many complex transactions, such as derivative instrument transactions?
2. Does management have a clear policy to manage financial leverage and liquidity?
3. Have there been significant changes in the cash management system during the current year?

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4. Are there many non-value-adding banking relations, such as idle cash balances, excessive bank
charges, insufficient usage of pooling and netting arrangements, or large inventories?
5. Are cash forecasts prepared and updated on a timely basis in order to monitor and control how
liquidity risk may impact company goals?
6. Are cash forecasts in line with business objectives and built to identify actions to manage future
opportunities and losses? Is company indebtedness in line with the strategic plan and constantly
monitored against it?
7. Is the number of days to complete the cash cycle excessive relative to the competition?
8. Is the time required to complete the operating cycle too long relative to competitors (i.e., the
period from the time a customer requests a quotation until the time receivables are collected)?
9. Are some subsidiaries borrowing while others are investing? Why?
10. With respect to these investments/borrowings, what are the terms? What is the volume?
11. Is there sufficient in-house expertise to manage both the risks and opportunities of cross-border
funds management?