Portfolio Approach to Cash Flow Variability

Abstract

Cash flow variability is driven by operational decisions and has implications for operating performance and valuation. Despite this, and the early influence that operations management had on cash flow management, the prevailing approach to managing cash flow variability is through external capital and financial hedging. We propose customer portfolio management as an operational hedge for reducing cash flow variability, and empirically validate this approach using a large database of customer-supplier relationships. Our analysis indicates that this is achieved by (i) pursuing customers with desirable order patterns that offset the cash flow variability from serving legacy customers and (ii) offering them more lenient trade credit terms, which can further reduce aggregate cash flow variability.

Keywords: Cash flow variability, Working capital, Supply networks, Trade credit