UncategorizedThe Pros and Cons of KPIs

The Pros and Cons of KPIs

Treasury departments are operating with fewer staff in an increasingly regulation-heavy environment. Treasury tasks that were once considered routine have come under the regulatory spotlight as they are deemed to be risky. In running a leaner treasury operation, a company needs to ensure it has the appropriate policies and procedures in place. To do so, financial professionals are increasingly turning to benchmarking to drive improvements in their organisations that can deliver more efficient treasury performance. By measuring their performance they can better manage their treasury operations.

There are two main approaches to benchmarking: firms can compare themselves to a group of peers, or they can benchmark their performance against internally-set key performance indicators (KPIs). Even if firms are benchmarking against KPIs, they should have some knowledge of what other treasuries are doing in order to set realistic KPIs. Benchmarking cash management practices and performance can help firms to identify areas for improvement.

One of the most significant challenges of benchmarking how a treasury is performing against its peer group is determining exactly who the company’s peers are. Corporate treasuries – like corporates themselves – come in many shapes and sizes.

Paul Higdon, chief technology officer at IT2 Treasury Solutions believes KPIs provide “a structured and objective environment for assessing the effectiveness, accuracy and rate of improvement of critical treasury processes”. Treasury KPIs are valuable at all levels of an organisation, potentially enhancing the quality, level of policy compliance and efficiency of treasury.

Corporate treasurers are increasingly being encouraged to adopt a KPI programme, under the direction of the senior management, often at board level,” he says. “A KPI programme is typically delivered through the implementation of an enhanced treasury policy, and manifests as a new set of mandatory processes, integrated with the treasury workflow.”

The choice of the optimal set of KPIs for a particular treasury can be an exacting exercise, adds Higdon, as the wide-ranging objectives include streamlining management reporting, improving the quality of all kinds of treasury operations and measuring, analysing and documenting operational compliance with treasury policy.

“The set of KPIs ultimately selected for a particular treasury will not only reflect the specific treasury policy and workflows that are in place; it must also reflect the business policies and priorities of the whole organisation. The KPI selection that works best for a given treasury will have been chosen through detailed analysis of those features of treasury operations that correspond to the highest levels of risk exposure,” he says.

No Common Standard

Intelligence gathering for establishing KPIs is a major challenge. A corporate treasurer can contact his treasury peers and friends and try to glean information about their practices, but such an approach is fairly ad hoc. Alternatively, the treasurer could use a consultancy or treasury organisation to undertake a large, statistical sample.

As all companies are different, there is no standard set of KPIs that can be measured against. Typical KPIs include:

  • Overall treasury efficiency, including cash visibility and cash pooling structures.
  • Core cash management efficiency, particularly as it relates to balance and transaction reporting and the accuracy of cash flow forecasting.
  • Working capital management, including days sales outstanding and days payables outstanding (DSO/DPO).
  • Liquidity management, such as cash flow forecasting and short-term funding.
  • Bank relationship management covering overall level of banking fees and transaction costs.
  • Risk management including mark-to-market (MTM) and hedging effectiveness.
  • Funding/balance sheet management, which takes into account net debt and earnings before interest, tax, depreciation and amortisation (EBITDA) as well as net interest expense.

In a paper on benchmarking, Higdon writes that in order to determine the right set of KPIs for a particular situation, the treasurer will need to be very clear about his or her organisational objectives and about the guidelines defining how those objectives are to be achieved – the treasury policy.

“When selecting KPIs, the organisation’s current or future capability to deliver the required results, at the required levels of accuracy and timeliness, should be considered carefully,” he states. “The selection of the appropriate KPIs for a given treasury naturally depends on the nature of the company’s business, as well as treasury’s defined role within it.”

As an example, he explains that one company might receive a high proportion of its revenue in a range of foreign currencies, whereas a similar-sized organisation might be highly leveraged, with a funding portfolio including a variety of bank debt and bond issues. In such a case, different sets of KPIs would be relevant.

KPIs based on financial outcomes provide a dependable, repeatable means to help the treasury explain their positions and risks to all areas within the company, he adds. Such KPIs enable performance to be accurately and consistently measured against the treasury objectives and policy defined by management. “They allow treasury performance to be objectively benchmarked and therefore provide a powerful tool to improve performance and to implement strategic change objectives,” states Higdon.

The Right Focus

Damian Glendinning, the Singapore-based treasurer of technology group Lenovo, believes that benchmarking in treasury “has to be managed with great care”.  It is important, he says, to measure the right things. “Unfortunately, it is very easy to measure the wrong things.”

For example, a focus on funding costs can overlook the fact that the funding itself may not be required if a treasury has good management of working capital. Additionally a good working capital metric, such as cash conversion cycle (CCC), can often push higher costs elsewhere in the business. For example, it can encourage business units to give expensive early payment discounts, or secure longer payment terms from suppliers, who may incorporate a higher funding cost in their base prices. Finally, a focus on bank charges may reduce the bank charges but result in damage to banking relations, which causes significant increased cost further down the line.

“The main point is that treasury activities, while they need to be monitored for efficiency, also need to be looked at in the context of their overall cost. This is always extremely difficult and it requires a high level of organisational maturity: the organization as a whole needs to be very clear as to its priorities,” Glendinning says.

Kelvin Walton, head of UK-based treasury consultancy TreasuryWise and gtnews contributor, reports that the majority of corporate treasuries are using internally set targets when they benchmark. “I have, however, met several corporate treasurers who are not benchmarking. This is not a good practice because a treasury needs to have an objective measure of its performance,” he says.

“It is clearly good practice to have objective benchmarks set for treasury performance in the areas where you are most at risk and which are the most significant to your operations. But whether a treasury can obtain useful, objective data from their peer group is doubtful because much of that information will be very sensitive. People have become very averse to commenting on anything that might have an impact on their share price.”

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