A Fitness Programme for Treasurers

by Yera Hagopian, Head of Liquidity, EMEA, and Andrew Betts, Managing Director, Global Head of Supply Chain, J.P. Morgan Treasury Services

Like the Olympic athletes of this summer, treasurers have excelled themselves in recent years, showing great responsiveness and flexibility through challenging times. While those Olympians look ahead to Rio in 2016, treasurers also need to be making their preparations for the future. The training regime for most athletes is gruelling but in essence relatively straightforward: diet, stamina, strength and technique. Likewise, the techniques for achieving optimal working capital and liquidity management are simple, but need to be combined in the right way to be fit for an uncertain future.

Twenty-five world records were set during the London Olympics as athletes constantly strove to exceed their own achievements and those of their competitors. Corporations are no different in their ambitions. However, with business strategy, organisational structures, cash flow dynamics, market conditions and regulatory frameworks continually evolving, the treasurers’ role in supporting the company in its pursuit of excellence is a constant one. Treasurers must therefore regularly revisit liquidity and working capital structures and processes to ensure that they remain world-class. This article outlines a simple, five-step fitness programme for treasurers to position the company for success and future growth.

Step 1:

Simplify bank account structures

The first discussion we typically have with treasurers is how to leverage credit balances held in bank accounts around the globe to fund debits in accounts domiciled elsewhere, thus reducing the cost of financing and maximising the value of cash. This is difficult to achieve when a company works with multiple banks and potentially hundreds of bank accounts. It is often impossible not only to manage the flow of funds effectively across accounts, but also to achieve timely visibility over these accounts at a global level. Furthermore, these accounts are typically costly and labour-intensive to maintain, and they can expose the company to counterparty risk.

With complex legal and organisational structures, diverse geographies and currencies, and frequent M&A, an optimal account structure one year may no longer be fit for purpose the following, so this is often a useful place to start when seeking to enhance liquidity. Typically, treasurers’ first objective should therefore be to rationalise the number of banking partners and accounts, leveraging primary banking relationships at a regional and global level as far as possible.

But treasurers, like athletes also need to set realistic goals. Any exercise to streamline bank relationships needs to be managed in line with geographic and market diversity. Few corporates achieve the ultimate goal of one global or even regional relationship and this presents challenges from a liquidity and counterparty risk perspective. Fortunately even that hurdle can be overcome with automated multi-bank sweeps which concentrate funds in a regional or global provider of choice.[[[PAGE]]]

Step 2:

Streamline connectivity for cash visibility

Having rationalised banking relationships and account structures, it is then easier to streamline connectivity to achieve visibility over cash information. This may involve banks’ proprietary electronic banking systems, integrated with internal systems, or a bank-neutral connectivity channel such as SWIFT that facilitates multi-bank communication.

Step 3:

Optimise regional and global liquidity

With an efficient and transparent account structure in place, the next step is to facilitate the flow of liquidity across the group in order that cash can be deployed where required, leveraging tools such as physical or notional cash concentration:

Notional pooling does not require the physical transfer of cash between accounts, and each business unit maintains control over its own bank account; however, when calculating interest, the bank includes all of the accounts in the pool and pays or calculates debit or credit interest based on the net balance. This can be a very useful technique in a decentralised organisation, and in other situations where cash needs to be held in the account of each underlying business unit for business control reasons. The disadvantage is that surplus cash held in different accounts cannot be accessed easily for investment or debt reduction. Pools can be single or multi-currency with the added benefit of minimising FX risk and margin costs.

Physical cash concentration involves the transfer of funds, usually daily, into a master account, leaving either a zero balance, or an agreed target balance on each subsidiary account. Cash concentration is typically quicker and easier to establish than notional pooling as the documentation is less onerous. Structures that involve more than one bank inevitably involve physical cash concentration as the benefit of set-off cannot be realised across the balance sheets of more than one bank. Furthermore, treasurers obtain direct control over cash, in addition to the benefit of interest offset.

The reality is that due to the complexity of multinational corporations’ cash and liquidity management requirements, and the diversity of the global regulatory environment, most treasurers have implemented a combination of notional and physical cash concentration. Although these techniques are familiar and well-established, it is important to revisit liquidity structures regularly to test their efficiency and ensure that the company’s financial objectives are still being met. It is often the case that the factors contributing to initial structuring decisions have changed, which may prompt a revised liquidity management strategy. For example, a country or a region may have been excluded in the past due to its low contribution, while revenues may since have grown; similarly, cash flows from acquired entities may need to be consolidated. Regulatory restrictions may also have determined the choice of liquidity management solution, which may have since been adjusted. Culturally, the company may have evolved, so that centralisation of cash is now more (or rarely, less) acceptable. Furthermore, as attitudes regarding counterparty risk have evolved, it may no longer be desirable to hold cash overnight in banks or jurisdictions that are perceived to be of higher risk, requiring daily or even more regular sweeps.

Step 4:

Leverage trapped cash

It is not always possible to repatriate cash to a regional or global headquarters, or the tax implications may make it undesirable to do so. In these situations, treasurers need to explore local investment options, such as time deposits and money market funds, to enhance yield and manage counterparty risk. In addition, there may be opportunities for intercompany lending. Even in jurisdictions where this is prohibited or restricted, there may be alternatives that achieve a similar effect. Finally, interest optimisation techniques are available from some global banks, allowing a combined approach to interest calculation without comingling or restricting the use of cash. As with notional pooling, interest optimisation only works across accounts held with a single bank.

Working capital and liquidity go hand in hand as part of any treasury management strategy as treasurers look to access liquidity across the business, accelerate cash flow, reduce working capital requirements and optimise the use of cash. Many companies also need to source additional financing, which in the past may have been primarily in the form of committed or uncommitted credit facilities. As bank financing has become more restricted since the global financial crisis, and regulations such as Basel III have been implemented, treasurers are increasingly building a funding portfolio comprising a variety of sources of financing; for example, we have witnessed considerable growth in corporate bond issuance. In addition, treasurers are seeking to unlock cash from the financial supply chain to optimise working capital and leverage their financial assets.[[[PAGE]]]

Step 5:

Harmonise days payable outstanding

Extending days payable outstanding (DPO) is a common way in which treasurers and finance managers seek to enhance working capital, with many companies embarking on initiatives to harmonise supplier payment terms across regions. This leads to improved cash flow forecasting and the ability to standardise payment processes. At the same time as optimising DPO, it is also important to ensure that key suppliers remain financially stable, so treasurers and procurement managers are increasingly working together to implement supply chain financing programmes. These provide the buyer with certainty over cash flows and facilitate standardisation of payment terms, but the benefits are no less substantial for suppliers. Suppliers receive prompt and predictable payment of invoices, and gain the option of an additional source of financing at an attractive rate, without compromising their own funding arrangements.

As supply chain financing programmes become larger, both geographically and in the volume of participating suppliers, companies are increasingly seeking funding in multiple currencies, which supports working capital strategies in local currencies. While only a very few banks globally are able to provide this capability, multi-currency programmes are fast becoming an essential requirement for large, sophisticated multinational corporations across a wide range of industries.

Step 6:

Maximise advantage of days sales outstanding

The parallel process to DPO for managing working capital on the supplier is days sales outstanding (DSO). Treasurers are becoming increasingly interested in monetising their receivables, sometimes incorrectly referred to as factoring. Factoring is a technique more commonly employed by smaller companies with a lower credit standing, while receivables financing programmes are more suited to large, highly rated companies. For major companies with a high quality customer base, the receivables portfolio is often the second largest asset on the balance sheet, so receivables financing can prove highly advantageous. For example, it can help to address negative working capital in some operating divisions, optimise working capital more widely across the group, manage customer exposure limits and smooth cash flow quarter on quarter to reduce volatility throughout the year. This is particularly valuable for some industries, such as the technology sector.

Fit for the future

Implementing the right liquidity and working capital optimisation techniques should not add complexity to the business; rather, the right combination of solutions should simplify and streamline treasurers’ and finance managers’ activities. When these become complex and burdensome, it is usually a sure sign that they are no longer meeting the business need, and need to be revisited and tested against current and future objectives. Working with the right banking partner can facilitate simplicity, clarity and fitness for the future, enabling treasurers to support the organisations that will continue to be world class from 2012 to 2016 and beyond.