Corporate TreasuryCentralisationCentralisation OutsourcingMaking the Business Case for Treasury Outsourcing

Making the Business Case for Treasury Outsourcing

Treasurers today are deeply involved in the financial supply chain and have more rigorous regulatory and compliance requirements to meet. In fact, treasury has taken on a more strategically important role in the organisation with front-line responsibilities for managing risk, working capital, controls and corporate governance. As a result, treasurers are looking for ways to free-up time currently spent on operational tasks – and outsourcing offers a solution.

But any decision to outsource treasury must be based on a careful analysis of the existing treasury organisation. A building block approach will ensure that all variables are properly evaluated and taken into consideration in the decision making process. Developing the business case will also offer a sound basis for discussion of the proposition with senior management and more importantly with the operating units that will be impacted by the change.

1. Scoping of treasury outsourcing – data gathering and analysis

The primary step in developing the business case is to complete a thorough review of all treasury related activities. The review will include an evaluation of the existing processes, controls, volume and frequency associated with each of the activities performed by treasury:

Figure 1: Identify strategic and non-strategic activities in these areas

Front Office Activities Back office administration
Intercompany funding Corporate Netting Center
FX Management Pool Management
Accounting and Reporting Business unit support
Reporting requirements Third party payments
Liquidity/Investment Management  

During this process it will be important to differentiate between strategic or core and non-core activities. For example, a strategic activity involves the identification and development of a strategy to mitigate a foreign exchange exposure. A non-strategic activity involves the execution, confirmation and reporting of the corresponding hedge transaction.

2. Identification of key corporate drivers

Identification of key drivers such as transparency of information, effective operational controls, centralisation, cost savings, adaptability, coordination and standardisation and automation will help to define the objectives and priorities associated with outsourcing to ensure that the proposed solution is tailored to meet your specific requirements.

3. Evaluation of existing processes

Once the primary activities associated with treasury have been defined and segregated into strategic and non-strategic activities, the company needs to objectively evaluate existing treasury policies and procedures, internal controls associated with those procedures, segregation of duties, management and financial reporting, supporting IT systems and identify any deficiencies that need to be addressed, keeping in mind the key drivers identified earlier.

4. Designing a new structure and process, based on best practices, information gathered and key drivers

Based on the review of the existing processes, best practices and key corporate drivers you should now be able to determine which activities to outsource and what to keep in-house. Once this has been determined, the company needs to evaluate the internal costs associated with supporting the new structure versus the service provider’s fees.

Below is a list of activities that are typically outsourced:

  • Intercompany borrowing/lending
  • Intercompany netting
  • Cash pooling
  • Foreign Exchange Hedging
  • Administrative and operational functions such as payment execution and bank account administration.
  • Accounting and reporting of banking and payment activities
  • Treasury system operation and administration
  • Transaction execution such as foreign exchange and payments

Activities that are usually NOT outsourced include:

  • Strategic “front office” decisions such as hedging and funding
  • Risk management decisions
  • Bank relationship management
  • Planning and budgeting
  • Negotiations with key vendors, customers, counterparties and banks

5. Cost/benefit analysis: in-house or outsource?

In order to make this determination a cost benefit analysis needs to be performed to evaluate the cost associated with managing these activities in-house versus an outsourced solution. The table below summarises the personnel and systems expenses that need to be evaluated.

Figure 2: Compare costs of activity in-house vs outsourced

Annual Cost In house outsourced
Employee    
Salaries    
Overtime    
Sick leave    
Pension    
Health plan    
Fringe Benefits e.g. car    
Subscriptions    
Social insurance    
Other    
Treasury Management Systems    
Implementation    
License fees    
Dedicated hardware    
Maintenance & support    
Allocated internal IT support    
Business application support    
Disaster Recovery    
Interfaces/Development Work    
Implementation    
License    
Maintenance    
Facilities    

Aside from employee-related expenses, companies need to consider the cost associated with investing in a sophisticated treasury management system, communication infrastructure and the associated support staff. From a purely economic perspective, the cost of a first class treasury management system usually tips the scale towards an outsourced solution.

Outsourcing – part of a wider decision?

In fact, a decision to outsource is rarely made in isolation. It is much more likely to be part of a decision to re-structure treasury operations, usually by centralising activities on a regional or global basis.

Treasury departments have to vie with other departments within the organisation for capital and other resources such as IT and for this reason alone, it will be necessary to develop a comprehensive business case that evaluates the expected return from any such project over a defined period.

The key to making a convincing business case at board level is to demonstrate how a project will result in economic or shareholder value, and the time frame within which this is expected. The return associated with the project will need to meet or exceed the company’s weighted average cost of capital or “hurdle rate”. A net present value analysis will, therefore, be required (see below).

In addition, a comprehensive business case will take into account both the quantifiable “hard dollar” and qualitative benefits, such as control and regulatory compliance, along with the related costs and expenses associated with establishing or restructuring a centralised treasury organisation.

Figure 3: Example of net present value analysis

  Year 1 Year 2 Year 3 Year 4 Year 5
Treasury Benefits:          
Cash optimization          
Intercompany Netting          
Bank fee reduction          
Total          
           
Expenses:          
Outsourced/Inhouse Mgt. Fee          
Global Transaction Fees          
Arrangement Fee          
Auditor’s Fee          
Directors’ Fee          
Sundry General Expenses          
Legal          
Tax          
Stationary          
Pre-tax Benefit (Loss)          
Effective Tax Rate (ETR) (xx%)          
Subtotal          
Tax Benefit          
After-tax Benefit          
           
Net Present Value @ X% WACC          
           

The net present value analysis (Figure 2) is a high level document for presentation to the Board. It should derive from and be supported by the comprehensive study of the existing treasury processes and company structure already described.

This analysis provides a summary of all of the elements of the project including the benefits and expenses associated with centralising treasury. The detailed cost/benefit analysis for outsourcing already described is a sub analysis which leads to including a line item for either an in-house or outsourced management fee in this project net present value analysis.

From decision making to action

By now you will have analysed your existing treasury processes; determined the quantitative and qualitative benefits associated with centralising treasury operations and determined which processes can be cost effectively outsourced. Based on this information you have built a compelling business case, including the ability to demonstrate an appropriate return in excess of your company’s hurdle rate.

Hopefully, you will also have convinced the board to commit to the necessary investment in order to achieve the calculated year-on-year savings.

If so, the decision will now be made and it is time to look to the implementation. Like the decision-making process itself, meticulous attention to detail will be rewarded here. You will need to work closely with your chosen provider to ensure success.

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