Lessons for treasury management from the financial crisis

Download PDF Version

Since the onset of the global economic crisis, companies have accumulated record levels of cash. In Europe, cash comprises 12% of total assets on corporate balance sheets – almost a third higher than at any point in the last economic cycle.¹ As a result, treasury management has gained a much higher level of importance within corporate strategy. For the treasury management function to generate maximum value, it must work seamlessly with all areas of the business, with processes adapted to create an integrated and holistic approach.

A PARADIGM SHIFT: THE KEY TO SURVIVING THE FINANCIAL CRISIS

From 2008 to 2010, management teams understandably focused more on cash flow and liquidity than on more traditional performance indicators like sales or EBITDA. Managing payment streams, ensuring ready liquidity, allocating cash effectively, and closely monitoring cash flows became a matter of life and death for many businesses.

To accomplish this, management required detailed and timely answers to questions about the security of future cash flows, the level of current liquidity, potential liquidity risks and the feasibility of liquidity release. Lending from banks or other intermediaries was severely limited, making it critical for CFOs to focus on internal sources of financing and liquidity. As a result, the treasury department, often operating out of the spotlight, had to move to centre stage, and frequently had to develop additional skills.

MUCH MORE THAN PAYMENT PROCESSING

Generally, the treasury department focuses on payment flows – including reconciling incoming payments, ensuring adequate liquidity, and managing financial risk. Typically in larger organisations it comprises three areas: a front office that conducts financial transactions, a back office that executes and records these transactions, and a middle office that is responsible for financial controlling. But the structure of the treasury department varies widely between small and medium-sized entities (SMEs) and large corporations. In large, multinational organizations, the importance of the treasury department, with its tri-partite front/middle/back-office structure, is already well established. In SMEs, often, the treasury department is made up of just one or two people, and its job is simply to process payments, making it effectively an adjunct to credit control.

Without question, in times of crisis it remains important to process payments in a cost-effective way that contributes to the company’s liquidity. However, excellent treasury management is about much more than just this. Of course, ensuring that electronic payment systems meet the company’s speed and security requirements, and processing inter-company payments, will always remain a central part of the treasury department’s work, but optimal treasury management also involves:
 

• Gaining clear visibility into current and planned payment flows

• Managing risks such as:
  ––Customer or supplier defaults;
  ––Currency and interest-rate hedging; and
  ––Security of raw material supply.

• Generating liquidity at all levels through:
  ––Working capital optimisation; and
  ––Opening credit lines.

• Ensuring appropriate financing is in place to meet longer term strategic commitments.

Of course, processes that are relevant to a company’s liquidity affect many different areas of the organisation – negotiation of loans, delinquency management within the credit control function, or even inventory management in production and logistics. As a result, the treasury management must be organised and run in such a way as to facilitate close integration with other areas of activity.

THE NEXUS OF HOLISTIC COMPANY CASH MANAGEMENT

If the treasury department is to function as a guarantor of liquidity for the company as a whole, its mandate must be expanded from the on-demand provision of financial resources to include the active management of all cash-relevant issues. This means not only taking into account the various interdependencies with other parts of the company, but also working closely together with the following functions in particular:
 

• Financial controlling: assisting with financial planning, especially when producing a short-term 13-week cash flow plan. This has proven to be the best tool for transparent liquidity management, as liquidity is calculated directly from incoming and outgoing payments, as opposed to being derived from the P&L forecasts and the balance sheet. In many cases, the financial controlling department’s monthly plans follow the treasury department’s 13-week cash flow plan.

• Sales: assessing the credit risk of customers, setting credit limits and individual payment terms, handling foreign currency payments, and hedging against exchange rate fluctuations etc.

• Purchasing: setting objectives for negotiating payment terms with suppliers based on the specific liquidity situation, foreign-currency purchasing and hedging, handling letters of credit for imports, raw-material hedging, and arranging performance securities.

• Production: monitoring levels of inventory and the liquidity tied up in it.

When involved in the management of domestic subsidiaries, the central treasury department should handle all payment transactions for the subsidiaries and provide them with liquidity as required for local expenses. Often, subsidiaries are involved in cash-pooling arrangements, which again the treasury department is responsible for managing. When done properly, this puts all the group’s cash reserves under effective central control, enabling management to prioritise the allocation of the available liquidity. And while this knowledge is always important, it is absolutely critical during difficult economic times.

FULL IMPLEMENTATION - NO HALF MEASURES

The financial crisis clearly demonstrated how vital visible and effective centralised management of liquidity is to a company’s success or even survival. The crisis shone a merciless spotlight on existing shortcomings: capacity or skills shortages, inadequate risk management systems, deficient IT infrastructure, and fundamental defects in back-office processes.

Consequently, many companies have resolved to focus much more closely on treasury management and to invest in both staff and software. Though this is a step in the right direction, it is not enough. Business processes throughout the company must also be systematically reviewed and adapted.

The full potential of treasury management can only be realised through a holistic approach involving all relevant areas of the company – and the prerequisite for this is a carefully prepared implementation plan and a critical analysis of staff skill sets.

DOES YOUR COMPANY HAVE SUFFICIENT VISIBILITY INTO ITS CASH SITUATION?
SIX KEY AREAS OF FOCUS:

¹UBS Investment Research, 2011.