Published: February 02, 2008
If you have already read the series of career interviews in this edition of TMI, you will have noticed a common theme - the profile of treasury, and individual treasury professionals, is dependent on demonstrating value and the benefits they bring to the organisation. Treasury departments are good at many things, and the implications of not having a well-run, effective treasury could be devastating for the company; however, few treasuries are demonstrating this in a way which is quantifiable and clearly understood by other parts of the business. A structured approach to performance benchmarking can be a way of achieving this; after all, it has been said many times that one’s true value depends entirely on what one is compared with.
As Deborah Thomas, Michael Page emphasises in her interview, other parts of the finance function, such as tax, are in a stronger position than treasury because their profile is higher and their value is more easily demonstrable; furthermore, as David Li, Market Manager, EMEA Cash Management at Citi emphasises,
“Benchmarking in treasury has been notable by its paucity. How do treasurers influence the corporate agenda or effect wholesale change unless they can sell their value to their business partners? In many organisations, the financial controller is heir apparent to the CFO rather than the treasurer because s/he is able to do this.”
Treasurers of most companies quantify or benchmark at least certain aspects of their business activities. The Treasurers’ Benchmark, the peer benchmarking service for corporate treasurers, illustrates the areas of treasury which are most commonly measured (see fig 1).
The most commonly adopted metrics which are formally measured are cost of debt (77%) days sales outstanding (DSO) and days payables outstanding (DPO) both at 62% and short-term interest income and expense. When informal measurements are included, bank fees, and the levels of decentralised cash predominate, although only 31% of companies formally benchmark their bank fees.
Joergen Jensen, Director of Product Management at Wall Street Systems explains,
“We see our clients defining KPIs (key performance indicators) in three areas: FX, Liquidity and Debt/Investment. Of these, FX is typically the easiest to measure, comparing activities against a budget or benchmark rate. In the area of liquidity, companies tend to look at how much of their cash is centralised under treasury’s control and will then often look at investment yield compared with a Libor rate or similar.” [[[PAGE]]]
Even so, the degree to which treasurers actively monitor and measure their performance is perhaps surprising - after all, only 54% of treasuries benchmark their operational efficiency, and only 15% do so formally. Bearing in mind that many companies justify their purchase of new technology on the basis of the operational benefits which they will gain, it is surprising that so few monitor their operational efficiency directly; without this, it is difficult to see how treasuries calculate a return on investment. Looking at Fig 1, what is also surprising is how much space there is to the right of the table: as an example, 38% of treasuries do not monitor bank account reconciliation exceptions, with potentially significant financial implications. The reality is that many treasuries only benchmark a small proportion of their activities, and some do not do so at all.
There are certainly challenges to effective performance benchmarking in many organisations. As Joergen Jensen, Wall Street Systems continues,
“Benchmarking the cost of debt is one of the most controversial areas to benchmark as the amount that companies have to pay for their borrowings will vary according to the company, industry and credit rating. If a company has a higher or lower rating than others in the same industry, or a credit rating changes, it may be impossible to establish a meaningful KPI.”
Anders Åslund, Corporates & Markets, Corporate Risk Advisory, Commerzbank AG indicates,
“Some of the tasks which treasury undertakes are difficult both to quantify and communicate since if they are achieved satisfactorily the result is avoidance of negative outcomes (e.g. cashflows and/or balance sheet did not deteriorate due to a lower/higher USD). The risks treasury is managing are typically not as well understood and/or focused on by people outside the corporate treasury, and the fact that these risks never materialised will consequently not always be something that is perceived as a value contribution achieved by treasury. The value treasury has added by managing risks, by eliminating them or at least reducing their negative impact, could be a challenge both to quantify and communicate as the risks turned out to be non-events for most people outside treasury. As a result, to demonstrate the value of treasury’s activities its performance needs to be measured using a metric which communicates the relevant risks in a straightforward way and, importantly, quantifies the opportunity costs/benefits achieved by managing these risks.”
Participants in the Treasurers’ Benchmark describe the difficulties in measuring some aspects of their business: one for example explains,
“It is very difficult for us to establish any consistent and worthwhile benchmark for monitoring cashflow forecasting accuracy, for example, as our cashflows can be very volatile; furthermore, it requires buy-in from the business units which treasury is not always in a position to influence.” [[[PAGE]]]
Another says,
“We would like to monitor operational efficiency but it is unrealistic for us to do so based on the number of ad hoc requirements we have to deal with on a daily basis.”
However, in some cases, the difficulties in measuring performance are because of issues with the underlying process. It is an old adage, originally coined by top executive H. James Harrington:
“Measurement is the first step that leads to control and eventually to improvement. If you can’t measure something, you can’t understand it. If you can’t understand it, you can’t control it. If you can’t control it, you can’t improve it.”
The profile of treasury, and individual treasury professionals, is dependant on demonstrating value and the benefits they bring to the organisation.
But why invest in developing the processes and system reports needed to benchmark treasury performance? Benchmarking as a one-off activity provides little benefit, except to demonstrate where treasury is already adding considerable value. More important than the analysis process itself is the action treasurers take to improve their activities which can be quantified by strengthening performance against the benchmark. A number of companies are already taking advantage of the Treasurers’ Benchmark to help measure their current performance and how this is improving. As Caroline Karwowska, Research Analyst at the Treasurers’ Benchmark explains,
“Many of our clients are surprised to see that their performance against peer companies is better than they would have predicted; conversely, the benchmarking process often reveals areas where they may want to be focusing more attention. We have seen participating companies using the findings from Benchmark Report to help prioritise and justify investment, measure their activities in a more consistent, objective and transparent way, develop better management reporting and raise the profile of treasury and its activities." [[[PAGE]]]
Anders Åslund, Commerzbank also emphasises,
“There is an increasing realisation that some elements of a corporate treasury’s performance can’t be measured quantitatively and as a consequence it is important to have a balanced scorecard of both quantitative and qualitative metrics. As an overall function, Finance is naturally an environment which is more quantitatively focused, and is therefore often less comfortable with measuring and appreciating qualitative benefits - despite the fact that much of the value that a corporate treasury can add is clearly qualitative. There is a growing realisation and recognition of this and many progressive corporate treasuries have developed balanced score cards which measure and communicate the quantitative as well as qualitative aspects of value generated by treasury’s activities. This is a promising development.”
There are myriad activities conducted in treasury, so in addition to external benchmarking, where should companies start when it comes to benchmarking performance and more importantly, which areas are likely to result in the most substantial benefits to the business?
Mark Beard, Head of Liquidity and Investments, EMEA, Citi illustrates Citi’s approach,
“Although many treasurers have found it difficult to monitor and quantify their performance in the past, there are many things one can quantify. We encourage clients to take a disciplined approach and focus on the areas which have the most impact on the financial performance of the business. In the cash management space, corporations typically measure things which have little impact on financial ratios and the balance sheet. For example, many US corporations focus on check float to try and increase DPO. This can have a disastrous effect on the predictability of cash flow. Predictability and volatility are the two factors with the most significant impact on the balance sheet and the amount of funding companies need to source for their working capital.
We use various measures with our customers to determine how to reduce volatility and how to increase cash flow predictability in order to make inroads into the financial health of the company. A significant measure is to track cash holdings as a percentage of sales turnover, taking into account that this will differ across industries, which will have different cycles and velocity of cash flow. Rather than looking at cash holdings, treasurers are often monitored on the return on investment - this is understandable, but it does not reward or penalise whether this cash should have been held in the first place. For example, we calculated for one US customer, which is typical in many respects, that while a cash centralisation project would create interest savings on short-term investments of $100,000, the balance sheet impact of aggregating cash and reducing the volatility of their cash needs was more in region of $60-$80 million.”
David Li continues,
“Prior to the credit crunch, a company typically sourced half of its liquidity from internal funding sources and half externally. If external funding sources dry up, companies are forced to improve their operational efficiency and their ability to optimise internal funding.”
Treasurers can reduce reliance on external funding by increasing the velocity of the cash cycle (i.e. transactional approach) and increasing the centralisation of cash (i.e. a balance sheet approach) - see fig 3.
[[[PAGE]]]
As Mark Beard, Citi continues,
“Two apparently simply questions which we frequently ask treasurers, which are often very difficult to answer, are:
(i) What is the right amount of cash for your business?
(ii) What drives the level of working capital you need?
Answering these questions is at the root of what we do. Measurement is not enough: acting on the results is what matters. As part of our research we have found that while variations in cash holdings occur due to different characteristics across industries, these variations are outweighed by differences within industries with companies having different degrees of cash effectiveness. Companies with greater cash effectiveness hold lower cash-to-sales ratios which in turn has an impact on profitability.”
Added to this, operational efficiency, such as straight through processing is key, and in particular, demonstrating the resulting economic benefit, as opposed to only the tactical advantages such as error reduction and resource implications.
Performance benchmarking is a critical function for treasury but is not currently as prevalent as it should be. Part of this is because treasurers have other priorities, partly it because it may seem ‘too hard’. However, as Harold S Geneen, former CEO of ITT, said,
“It is an immutable law in business that words are words, explanations are explanations, promises are promises but only performance is reality.”
It is important to have a balanced scorecard of both quantitaive and qualitative metrics.
While some aspects of treasury are difficult to quantify, at times the underlying processes are as much the problem as the metrics to measure them. Unless treasury develops its ability to demonstrate the value it adds in a consistent and objective way, it is hindered in its efforts to influence the corporate agenda, develop its role and take into account important treasury considerations in major decisions. Anders Åslund, Commerzbank concludes,
“The treasurers’ risk management skill set has the potential to add more value strategically to the overall business than is often the case today; illustrating and communicating the value generated by this risk management skill set is an effective way to ensure that treasury is perceived as a strategic business partner, as opposed to merely a cash manager”
Measuring performance both internally, and externally using facilities such as the Treasurers’ Benchmark can form the basis of substantial treasury transformation and as Citi explains, major economic advantage to the business.
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