Cash & Liquidity ManagementCash ManagementA Strategic Agenda for Corporate Treasury

A Strategic Agenda for Corporate Treasury

“Never waste a good crisis”. This oft-cited quote – recent users include Hillary Clinton – has become a mantra for those in search of opportunities to deliver value in these difficult times, and seems a good motto for reflection at the start of a new budgeting season. The past few years have been a rollercoaster ride for many corporate treasury professionals. The 2008 credit crisis and its aftermath stress tested common practice and, occasionally, demonstrated how tangible ‘opportunity losses’ can be. Given the recent past, what should corporate treasury consider as their strategic focus for the next few years?

What Kept You Awake?

By the end of 2007, daily treasury operations had become routine for most treasury professionals. There might still have been room for some adjustments, but in general many corporate treasuries were content with their basic processes. Tactical and strategic treasury agendas often contained mostly ‘nice-to-haves’ and even developments on the technology vendor front seemed stagnant.

The collapse of Lehmann Brothers in September 2008, however, marked an abrupt change. It sent a shockwave through the global economy, far beyond the periphery of the financial industry. The world had to accept that we were living on a volcano that could no longer be contained. We had to come to terms with the fact that the financial industry could no longer kick-start the economy as it had done in past decades. The failure of the financial industry triggered a domino effect that threatened the business continuity of many companies on a scale not seen before. Companies were not only confronted with falling demand and increased inventory levels, but also with the real possibility of failure of key banks, real potential for loss of principal investments, the necessity of renegotiating existing loans, major hikes in interest cost and last, but by no means least, unavailable liquidity for paying bills.

Overnight corporate treasuries had to go into overdrive, collecting the necessary cash and cash flow information for executive management. Even when the company was not itself at risk from the turmoil on financial markets, management had to deal with the consequences of business trading partners not being equally lucky. The contracting economy also meant for many companies that substantial amounts of cash were released from working capital with little solid or worthwhile investment opportunity.

Figure 1: Shifting Priorities for Treasury Against the Background of Major Events

Figure 1 PwC - Shifting priorities for treasury

Source: PwC

Ever since the collapse of Enron and the passing of the Sarbanes-Oxley (SOX) legislation in the US, compliance and transparency had been a major theme for treasury. Although it has always been acknowledged that day-to day-decisions within treasury may have a major impact on profitability and corporate reputation, the function was only impacted to a limited extent by external regulation. Both the SOX regulation on internal controls and the requirements of IAS 39 on hedging process changed this to varying extents. Despite the significant costs associated with regulatory compliance, and in a knee-jerk response to the financial crisis, a whole series of regulations, new or revised, will affect the treasury function in the coming years. Basel III, Dodd-Frank, IAs 39’s successor IFRS9 and the European Market Infrastructure Regulation (EMIR) are merely the latest examples.

Taming Your Nightmares

For most treasurers the long hours and additional workload during the immediate aftermath of the credit crisis provided valuable input for their longer-term strategic agenda. If the 2008 crisis demonstrated only a few things, they included the following significant hard truths:

  • External credit will not, for the foreseeable future, be abundant again and for various reasons will remain expensive for many years to come.
  • Securing access to liquidity is a prerequisite for business continuity.
  • Labelling risk does not compartmentalise it, let alone quarantine it.

The events of 2008 gave textbook concepts like counterparty risk, trade credit risk, systemic risk and liquidity risk a very real face and by no means a friendly one. Cash visibility and cash planning have become a daily obsession for many corporate treasurers, since monitoring liquidity and credit risk has become a matter of survival.

The logical consequence of the demand for instant, real-time management reporting is that corporate treasury has to become more effective in interfacing and integrating its departmental processes into the business across the entire enterprise. To phrase it differently, treasury has to become an enterprise-wide process rather than a corporate department.

Enterprise treasury management differs from traditional treasury, in the sense that it owns exposures upon generation by the business rather than managing those exposures only to the extent they are identified and reported by local staff. Effective enterprise treasury management requires a corporate-wide mindset, or culture of cash, risk and compliance.

The following sections discuss the role of treasury in each of these three cultures.

Corporate cash culture
A cash culture builds around ‘cash efficiency’, which is about more than just managing the cash within the treasury chest. It is best characterised as cash flow management with the objective of ’just-in-time’ cash management, securing the company’s ability to pay its bills in time. A successful cash culture will typically acknowledge that:

  • Cash is a corporate resource. Cash is more than a bank balance and the affiliate that legally owns a bank account has no ultimate title to the cash in the account.
  • A sale is completed only after the cash is collected from the customer.

A cash culture puts collection from customers at par with revenue recognition and evangelises the time value of money. It galvanises the organisation around facts such as:

  • Every 3.5 days’ sales outstanding (DSO) represents a funding requirement of 10 million per 1 billion sales.
  • At a weighted average cost of capital of 8% each 45.6 DSO equals 1% gross margin.

The implementation of a cash culture brings treasury within the orbit of core business operations. It will make treasury a business consultant and partner for strategising on trade terms and conditions, working capital management and payment execution. A cash culture will most certainly make a payment factory and in-house banking readily accepted and no longer a corporate intrusion in local affairs.

A focus on corporate cash expands treasury’s role and responsibilities in relation to working capital management (WCM). With credit lines under pressure for some companies and mounting cash for others, flexible trade credit terms and vendor financing can provide an alternative source of funding and tools for (strategic) supplier relationship management.

Another reason for implementing a cash culture and having treasury involved in day-to-day WCM of the enterprise is that this approach might prove to be instrumental for managing the balance sheet and other financial ratios more effectively. Such balance sheet and ratio management is key for maintaining a credit rating and, consequently, also for managing profitability, cost of funding and access to credit.

Figure 2: Summary of the Potential Contribution of Treasury to a Cash Culture
Figure 2 PwC Potential contribution of treasury to cash culture
Source: PwC

A cash culture almost naturally extends treasury departmental roles to enterprise-wide roles and responsibilities. For instance, the themes discussed in Figure 2 of ‘full cash visibility’ and ‘grip on cash’ expand corporate treasury’s responsibility for bank relationship management to include responsibility for day-to-day bank connectivity, irrespective of whether a bank account is controlled by treasury, is stand-alone or is only indirectly linked to corporate cash pools. This is because, by definition, full visibility implies accurate and (near) real-time consolidated reporting on all balances, including those of stand-alone accounts. Consequently, a project aiming for full cash visibility has to consider:

  • The creation of a bank statement hub and central repository that is linked to both treasury management systems (TMS) and (local) enterprise resource planning (ERP).
  • Automation of bank statement upload and auto-matching.
  • Integration of bank balance reporting and cash forecasting.

The themes ‘understanding cash’ and ‘controlling cash’ bring treasury in even closer connection with businesses across the enterprise. These themes insert treasury in daily processes of local units and entail a transfer of decision-making power and/or control over the timing of payment execution and business terms and conditions, including trade credit terms, trade credit limits and business partner approval.

Corporate risk culture
A risk culture builds on the principle that:

  • Risk is inherent to doing business.
  • Risk drives the quality of the cash flow and the company’s business continuity in the best interest of all stakeholders.
  • Managing the volatility of projected cash flows adds value for all stakeholders.

A risk culture zooms in on the concept of ‘risk adjusted return’ and has to be developed hand-in-hand with the cash culture. The critical linking topics between cash and risk are cash flow and WCM. There are two key dimensions to treasury’s contribution to a risk culture, being the management of risks arising from:

  1. Business operations.
  2. Financial market exposures.

The business operations dimension of a risk culture concerns trading partner acceptance, enforcing trading limits and credit management in general. It also concerns the risk adjusted provisions booked for overdue outstanding trade balances. A risk culture should make sales and procurement sensitive to the financial viability of customers and vendors, and gives incentives for negotiating risk-adjusted trade terms with business partners. An ultimate consequence of a risk culture might be that corporate price lists and trade terms and conditions differentiate by the (implied) credit rating of business partners similar to pricing strategies in the financial sector.

Figure 3: Action Plan for Corporate Risk Culture
Figure 3 PwC Action plan for corporate risk culture
Source: PwC

The financial markets dimension of a corporate risk culture centres on balance sheet management, optimising key financial ratios and reducing cash flow variability due to market price risks. The focus on financial ratios and weighted average cost of capital (WACC) is important for the company’s ability to assure access to external funding from shareholders, banks and, where applicable, other formal or informal investors. Following the introduction of Basel III, financial markets will be more differentiated as well as highly sensitive to risk and credit ratings. Consequently, companies have an interest in managing key input variables for (implied) rating models as these define their access to financial markets and the cost of funding.

Corporate compliance culture
Operational efficiency and transparency, along with process tooling, define a compliance culture. The key objectives are to protect corporate reputation and minimise operational risk. A compliance culture will focus on:

  • Process standardisation and automation.
  • Global applications with strong workflow management functionality.

The scope of potential treasury projects related to the compliance culture dovetails nicely with those associated with implementing cash and risk cultures. Almost naturally, the compliance agenda drives the deployment of centralised and integrated systems for the support of business processes irrespective of the physical location of operating staff. It is no wonder that those responsible for a company’s internal control system welcome payment factory/in-house banking (IHB) and bank connectivity hub projects, as they make the sensitive payment process more standard and transparent and hence typically more readily compatible with the key control framework.

Figure 4: Action Plan for Corporate Compliance Culture
Figure 4 PwC - Action plan for corporate compliance culture
Source: PwC

Responsibilities, KPIs/Incentives and Reporting

We labelled the different elements of the strategic agenda as ‘cultures’ for a good reason. It is important that cash, risk and compliance are part of the corporate mindset, in the same way that sales, growth and profitability are already. Successful implementation of a (new) culture requires cross-functional collaboration, endurance and executive sponsorship.

Executive sponsorship is necessary because the key to success is the roll out of a new, consistent set of SMART key performance indicators (KPIs) and related incentive schemes for most business and corporate departments. Treasury has an important role to play in defining new incentives, because the underlying KPIs will have to be geared towards liquidity and risk.

New KPIs do not necessarily overwrite existing metrics. Sales incentives, for instance, will continue to be important. Pay out of sales bonuses might be (partially) tied to collection from the customer within the agreed timeframe. In addition, a sales bonus might be made dependent on the (implied) credit rating of the customer.

As responsibilities are shifted incentives may be transferred between departments. In the case of a full payment factory, it may no longer make sense to keep local businesses responsible to days payable outstanding (DPO). Instead the payment factory-shared service centre (SSC) should be responsible for DPO, while local business should be monitored on the period between invoice receipt and acceptance.

Traditional ratios might not adequately support the full scope of cash and risk cultures. Periodic DSO, for instance, does not properly reflect the actual trade credit given to customers. Instead companies might consider as a working capital KPI an amount-weighed actual trade credit term and standard deviation from the average.

Under a new incentive scheme, treasury will be allotted responsibility for cash balances on all bank accounts and the obligation to fund accounts on time or just-in-time. Management of account balances held in open economies can be included in service level agreements (SLAs) or can be part of IHB agreements, whereas the management of account balances in restricted economies could be incorporated in agency treasury agreements.

Tracking and reporting the underlying KPIs is pivotal when redesigning incentive schemes. If local managers are to become responsible for swiftly approving supplier invoices such that they can be discounted under a vendor financing scheme, a dashboard has to report on the elapsed time between invoice and approval date at an individual invoice level. Consequently, the implementation project for a cash and risk culture may include a data mining project stream. The data mining team might, on the back of its dashboarding work related to the new cultures, contribute to a more scientific and more reliable approach to cash forecasting.

A Rewarding Experience that Delivers Real Value

Embarking on implementing a strategic agenda along these lines will require vision, commitment and a substantial investment in effort and resources. However, the overall benefits of a functioning cash and risk culture can far outweigh the project effort. Making cash and risk part of the corporate DNA improves the quality of cash flow and of financial ratios by aligning the interests of diverse business functions. It also improves information on daily liquidity.

As a consequence, such an approach contributes positively to treasury’s dialogue with stakeholders and most certainly to the cost of funding/return on assets. Additionally, improved control over cash flow and more effective WCM will expand funding options for the company and its vendors and thereby contribute to securing supply and to business continuity. On a personal level, and from a career development perspective, there is huge reward here for the treasury professionals that are willing to take on the challenge, including the opportunity to expand into new responsibilities and establish a far closer alignment to the business.

To read more from PwC, please visit the company’s gtnews microsite.


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