Achieving an Efficient Cash Management Structure: Overcoming the Challenges
Just when you think you have an efficient cash management structure working smoothly along comes another development, such as a new operating subsidiary in a new country, a change in tax requirements or a systems upgrade offering new functionality. These types of development can allow you to adjust your structure to incorporate the change but there comes a point when a review of your cash management structure becomes a necessity and an overhaul is required. This article considers some of the challenges faced by treasurers in their drive for more efficient cash management.
When updating a cash management structure the key challenges for any treasurer are:
The extent of the challenge will certainly depend on the efficiency of your current structure and the number of accounts and geographic locations of your business.
The range and complexity of areas to review obviously depends on the company (or group of companies). External and internal factors will impact what is reviewed and the importance of the area under review should determine both the depth of the review and the impact of the results. External factors include legal environments for the countries in which the company operates. Internal factors include company policies and the overall nature of the company’s business activities.
The following are some of the more challenging aspects to consider. This is not in order of priority nor is it a complete list of what should be covered.
Typically, changes to your cash management bank(s) are driven by policy requiring a re-tender of the business in conjunction with perhaps concerns about your existing relationships, such as poor service or credit quality, falling behind market developments in products, services, technology or rationalisation of bank relationships. The process to re-select your bank partner(s) and any subsequent migration can be time-consuming and costly but it can be an essential first step towards improved efficiencies.
Legal issues will have a major bearing on your cash management structure. Legal/regulatory restrictions will force decisions on a number of issues, such as the location of bank accounts (can residents hold accounts abroad?) and the operation of the account (can interest be earned, are overdrafts permitted, can FX be executed?). Can pooling be established and is the subsidiary able to provide a legally enforceable cross guarantee? In some countries, cash can be trapped and consideration needs to be given to how this can be best managed. What local regulations are there in respect of payments and receipts (e.g. cheques cannot be issued if they will not be honoured when presented)? Legal reviews are typically a costly and time-consuming process, especially if external lawyers are needed.
Tax issues can also affect where the account is held (e.g. does the account create tax residency, is there withholding tax due on interest income/expense?), the adoption of pooling and/or zero balancing (intercompany lending, transfer pricing and withholding taxes) and other areas (e.g. conflicts with Controlled Foreign Company requirements). Needless to say, while valuable, tax reviews can be expensive and drawn out.
Credit facilities are needed to operate effectively so treasurers must consider if the company is sufficiently creditworthy to obtain the level and range of credit facilities at appropriate spreads. Completion of the related credit documentation can be a complex and lengthy process, especially if notional pooling is to be established in many different countries. You need to ask questions such as will the required clauses in the cash management documentation breach existing covenants in loan agreements (e.g. negative pledge, pari passu clauses)?
The effective use of technology is a major contributing factor to successful cash management. There are multiple challenges here due to the number of systems that are used in treasuries, such as banking and market information systems, treasury management systems (TMSs) and enterprise resource planning (ERP) systems. Efficiency requires integration, not always a quick or easy task to implement. The systems need to provide the necessary functionality for the company to meet its business requirements at appropriate cost and to be implemented within reasonable timeframes. As a result, a review of the systems alone can be daunting in today’s ever-changing environment in this area.
If the treasurer has the authority to impose policy and procedures across the group, this makes it easier to establish effective working relationships. If not, powers of persuasion are required for both subsidiaries and joint venture partners to ensure that they comply with requests to provide their expertise in local requirements and to then change their processes.
It is essential that the existing arrangements and requirements for both subsidiaries and treasury are fully understood. Asking the right questions is essential, as this minimises the impact of any surprises further down the line.
But how can you tackle all of these issues? Ensuring everything is addressed can be managed more effectively by creating a comprehensive checklist for each subsidiary stating what needs to be reviewed under each key element, e.g. bank accounts, pooling structures, payments, collections and credit facilities. Then, for each element, list further things to consider. For bank accounts, this could question if the subsidiary can legally operate a bank account offshore or if there is withholding tax on interest income. For pooling, this could cover whether the company is incorporated in a jurisdiction that upholds cross-guarantees. This will also be a useful tool when adding new subsidiaries in future.
As with many other aspects of treasury, the second key challenge is the balancing act between the advantages and disadvantage of each option even in relatively simple cash management structures. For example, a notional pooling structure across all accounts/currencies may not be possible due to all sorts of reasons. Do you adopt a zero balancing/cash concentration structure to standardise your structure, or maybe a mix of both zero balancing and pooling? Some decisions are not so clear-cut where a number of options are possible but have a range of different disadvantages. As a simple example, if the requirement for a foreign currency bank account is marginal, the choice is the cost of the bank account versus the poorer exchange rates.
To address this issue, it is essential to determine some clear objectives that support your vision of ‘optimum cash management’. These will depend very much on the environment in which the company operates, the current structure, company policies and even the personal choices of the treasurer. For instance, a growing, profitable company may be less concerned about minimising bank charges at the expense of developing a structure that can be extended more simply. Of course, an objective, for example, to maximise bank interest income is not the same as one to optimise bank interest income.
Examples of other objectives could be:
Importantly, make sure the list of objectives is not too long otherwise this defeats the purpose. Some of the objectives will probably create conflicts with each other. For example, using one bank may mean that some bank accounts are not located in the country of the currency (if the bank has no branch presence) so the cut-off times for payments in that currency are not maximised. It is therefore good practice to rank your objectives to further assist the decision-making.
Setting up the new systems/processes is itself a major challenge for the treasurer. Projects invariably have restricted resources and budgets, tight timeframes and can suffer from the knock-on effects of other group initiatives (e.g. acquisitions or other major systems projects) or events in the financial markets. Don’t be too adventurous or aggressive with timeframes unless you are prepared to invest in the resources and you have ready access to the skill sets needed. Be prepared for any surprises.
If the structure is complex it becomes more difficult to understand and may be less flexible. It then becomes difficult to maintain as further changes are required. Many types of change are forced on the structure and often are outside the treasurer’s control. Market developments are a good example and, in particular, improvements to payment systems.
Across the globe, there are many opportunities to further enhance cash management. In the UK, Faster Payments and the decline of cheques are changing the available choices. The introduction of the new single euro payments area (SEPA) payment instruments will allow companies to pay and collect in a more standardised and streamlined manner. In markets that historically favoured cash and cheques such as India, electronic payment methods are being enhanced and becoming the norm. Some of these developments can be adopted by choice, but others will be mandatory. An example of the difficulty in undertaking a mandatory systems change is demonstrated by the fact that a significant number of UK-based companies left it very late to switch their technology platforms for BACS processing despite being given two to three years notice.
A constant challenge is the complexity, time-consuming and costly nature of the review and implementation stages for cash management – but don’t be put off. A simple cash management structure can reap many benefits. In the drive for efficiency, treasurers should monitor and where possible manage change in order to do what they can to simplify the process.