Making the Change: How to Decide if Centralisation is Best for You
In the current environment, where control and risk management are high priorities within the finance function, treasury centralisation remains the main avenue to improve management control and efficiency. While the benefits of centralisation have been unchallenged for a number of years, and backed by experience, it hides the fact that not all companies are actually achieving the same level of benefits and efficiency in their centralisation process.
Best practice, by its very nature, is an elusive target. Reaching the highest level of efficiency will require optimising the processes (through standardisation, automation, centralisation and control), working with a number of stakeholders and partners (outsourcing, technology providers, partnership banks) and also considering the company structure (single entity, multiple entity using a shared service centre (SSC), or centralised treasury using a European Economic Interest Grouping).
The optimum combination of these three aspects will obviously depend on the company size, its structure, business model (eg B2B or B2C) and the way it developed – through organic growth or acquisition.
The best treasurers keep a critical eye on their existing processes with a view to introducing innovation that can be roughly divided into three areas:
Despite the European directives on payments within the eurozone, the Single European Payments Area (SEPA) and the implementation of EBA Step2, the promises of a single payment market have yet to fully materialise and offer significant benefits for the corporate sector. One has also to recognise that treasurers are also busy working out the implications of Basel II and IAS 39.
However, for large companies handling significant volumes of FX transactions, the advent of viable continuous link settlement (CLS – the banks’ response to the regulators’ concerns over the ever-expanding amounts being exchanged in the FX market) solutions for corporate access are often overlooked. The management of FX settlement risk is quite topical as we are seeing a revived growth of hedge funds on the one hand and on the other hand, treasury centralisation and establishment of a netting centre have never been easier through Internet technologies. Controlling settlement risk however is not a luxury, rather it is part of the best practice that the treasurer of an multi-national corporation needs to integrate into the treasury process.
Indeed the process redesign for FX settlements, which is at the core of CLS, not only allows for reduced risk but also improved automation. While banks are using CLS to synchronise the two legs of an FX transaction, a logical element of that process is the elimination of failed or unmatched items, without which automation is not possible. This might sound trivial, but a number of companies are spending considerable effort managing the small fraction of transactions that are either going astray or not being credited quickly enough to their bank account. A customer who has recently implemented a global treasury centralisation process, incorporating CLS corporate access, commented that outsourcing all eligible settlements meant that they were able to allocate treasury resources to more value-added functions.
While new technologies can be compelling, the actual improvement to the bottom line can often prove to be more elusive than initially anticipated. E-commerce has brought significant efficiency but mostly to a restricted number of applications or industries, and mostly for non-strategic purchasing in the corporate sector, i.e. T&E and office supply.
When it comes to the wider world of treasury activities, many companies are operating in a non-integrated manner. A recent survey by Unisys revealed that among around 100 treasurers, 60 per cent would like to obtain better ERP integration, particularly for their cash forecasting process.
When one considers that 53 per cent of treasuries are relying on spreadsheets for their cash forecasting, it is not very surprising to see that 48 per cent indicated that they were either somewhat, or very, dissatisfied. In the same survey, treasury professionals indicated that 29 per cent were either changing or planning to change their cash flow forecasting process within six months.
Forecast needs vary depending on the size and organisation of a company. Quite often, treasuries of large companies integrate the flows of a number of subsidiaries, and therefore the averaging of commercial transactions is such that it is very rare for a single transaction to significantly affect the overall position. In addition, a number of treasurers have confirmed that they handle their major treasury flows separately or use a dedicated treasury workstation. Apart from these large flows, many treasurers felt that it was sufficient to invest or fund their actual position rather than a projected position. However, this is not the same for all industries, particularly when trading is an important element. It is even less so for smaller companies, which can’t afford the latest treasury workstation and who do not integrate the flows of a variety of entities. For such organisations, a quarterly VAT payment in one entity for example, would significantly affect the company’s liquidity position.
The quality and timeliness of information, both from banks and subsidiaries, are crucial to achieving the best level of efficiency. Banks are looking at ways of improving their services in terms of reporting, particularly adding the ability to send payment-related information when the clearing infrastructure provides inadequate information.
The key problem is commonly a lack of proper and efficient information from subsidiaries. A number of technology companies have been working on Internet-based services that are simple to roll out, easy to use and provide improved information to the treasurer.
While each company can evaluate the benefits of an improved forecast of their treasury position, the main areas that can be immediately quantified are:
It is also important to emphasise that such an improved process will bring some qualitative benefits that, in the long-term, could be even more substantial to the business overall. Indeed, improved quality of management and treasury reports will facilitate better communication and support among operating units.
One point often raised by local entities is that centralisation could mean losing touch with the day-to-day, hands-on element of the business. Local treasuries know the people and the culture and this can be very important.
Clearly across western Europe, the stability of the market and the fact that most countries are operating in euro simplifies the role of the treasurers and allows for a simpler centralisation.
Local knowledge, however, remains the key for customer interaction and, therefore, a number of companies have decided to restructure in order to focus local entities on sales and customer interaction, including credit control, while centralising the other functions. However, to avoid the complexity of implementation of a multiple-entity SSC, it can be more efficient to move to a single pan-European structure. In such a scenario, goods are obtained, manufactured directly or transformed by service providers, and delivered to the countries where the local entities do not carry the inventory but simply sell and receive a commission for it.
We have seen two examples of cases where this model can offer optimum benefits. The first group includes branded consumer goods companies where the brand image, the ability to offer uniform product positioning and marketing mix across Europe are critical.
The second group relates to companies distributing in southern Europe and sourcing products in northern Europe. The large gaps in acceptable payment terms between the 20 to 40 days in northern Europe and the 60 to 80 days actually observed in southern Europe create a significant need for financing and potentially limits the ability to increase sales. Finally, carrying the inventory or financing costs in the centre allows the local subsidiaries to focus on sales, reduce their administrative work and costs, minimise the required capitalisation in the distribution countries and maximise the profits in the location of the single legal entity.
The key to maximising the benefits of treasury centralisation is the combination of these three components. No centralisation could be successful without some standardisation, which itself is a pre-requisite to increased automation and control. The selection of partners is also critical and requires scanning the market for providers in all areas, from service and IT companies to banks. Integration of the various processes using the selected providers is often one of the most formidable challenges. Finally, the type of solution selected has to be driven by the structure of the company. In many instances, the treasurer will have a key role in leading the implementation of these changes.