Corporate Treasury and Cash Management

Most treasurers would consider that their primary role in the organizations they work for is the management of financial risk. This financial risk, as far as it affects the corporate treasurer, can be defined as the extent to which an organization may incur losses as a result of:

The previous chapter discussed how treasury policies flow from the identification and measurement of a company’s principal treasury-related financial risks. This chapter starts with a further discussion of these risks as they relate to debt management, interest and foreign exchange risk. It covers such questions as: ‘What factors determine a company’s treasury policies?’ ‘How does a company establish treasury policies?’ ‘What should periodic treasury reports look like?’ and ‘What information should they contain?’

One of the questions that a corporate treasurer is often asked is: ‘How much debt can we raise?’ This question is usually posed when the company is planning either a major expansionary capital expenditure programme or a significant acquisition. The result of either of these activities may be to push debt levels up to or beyond those levels that have hitherto been considered normal, or that the company has been used to operating with.

It is often said that every company should have bank finance as part of its core debt. The reason for this is generally the very flexible nature of bank finance. This flexibility is reflected in the different maturities, currencies, availability, repayment options and structures available with bank finance. The object of this chapter is to provide a background to the principal elements of bank finance and how it is used by the corporate treasurer.

A bond represents a legally binding obligation on the part of the issuer of the bond to pay interest on the bond on the stated coupon dates and at the coupon rates and to repay the principal on maturity. The majority of bonds that are issued by corporates pay a fixed rate of interest throughout their lives.

Most treasurers seeking to diversify their debt financing away from the bank market, or aiming to expand the maturity or average life of their company’s long-term debts, will need to examine the bond markets. This chapter explains the principal bond markets available to a corporate, how they operate and the advantages and disadvantages of bond markets in relation to bank finance.

Many treasurers find that at some time in their careers they are required to put some form of specialist financing in place. This financing may be a securitization of some of the company’s assets, a sale and leaseback of properties, or the stand-alone financing of a project. This chapter attempts to give the reader a broad introduction to some of the principal considerations that are involved in these specialist types of finance by looking at the basic elements of asset securitization. It does so by addressing the following questions: What are the basic elements in a securitization? Why should companies consider such a financing and what are its benefits? What are the obstacles to a successful securitization?

An explanation of the mathematical basis and methodology used in the calculation of option prices is generally well outside the scope and requirements of most corporate treasurers. Virtually all treasury management systems have modules that calculate option prices upon the input of the necessary parameters, and in addition there are a number of inexpensive stand-alone software applications that perform the same function. It is necessary, however, for the corporate treasurer to understand the basic mechanics of options and above all what drives option prices. This understanding is essential if the company’s financial risk policy is to be effectively implemented and the treasurer is to make the correct decision between different treasury products, and to tailor these products to his or her own particular requirements.

Foreign exchange (FX) is the exchange of two different currencies on a specific value date. In any FX contract there are a number of variables that need to be agreed upon. These are:

An interest rate swap is a legal arrangement between two parties to exchange interest rate payments or receipts on a notional principal amount, for a specific period of time. The interest obligations are in the same currency. There is no exchange or payment of principal under an interest rate swap.

In the chapter on bond valuation, the yield to maturity (YTM) method was explained. The yield was that single rate which discounted all future cash-flows arising on a bond back to the current market value (net present value). The advantage of YTM is its simplicity. Its disadvantage is that it assumes all coupons are re-invested at the single rate. The zero-coupon curve attempts to overcome this disadvantage.

The different steps involved in managing financial risk should now be quite clear. They are as follows:

The objectives of cash management are to: It is worth remembering that the treasury cash manager only manages cash at one narrow point of the company’s business cycle. That is from the time that receipts become usable funds until the time those funds are used again to make payments. However, an organization is concerned with the effective management of cash at every point of the business cycle. For instance, efficient working capital management will in practice be linked to a company’s production, sales and marketing and administrative controls. These are established to ensure an efficient control over the company’s business processes and to minimize the use of working capital. A company will establish fixed asset controls to ensure not only that fixed assets are purchased and installed as rapidly as possible, but also that their cost is minimized (as far as is consistent with performance). Ultimately, every employee in an organization is a ‘cash manager’: cash is the lifeblood of every business.

When considering an international transaction — for example a payment in US$ by a Singapore company to an American company — a payment process needs to be used that can be cleared through the American banking system. This is because the American company needs to get value in US dollars. However since the Singapore company’s bank accounts are in Singapore dollars and are all maintained in Singapore, there also needs to be a way to make payments from Singapore to the United States. The means of effecting this is the correspondent banking system and the SWIFT message system.

Pooling is the offsetting of the credit balances on certain accounts against the debit balances on other accounts, with interest being charged or credited on the resultant net balance. With true pooling (known as notional pooling) there is no movement or co-mingling of funds.

Liquidity management involves the management of day-to-day cash deficits and surpluses. A company’s cashflow is never stable from one day to another, one week to another or one month to another. Payrolls and suppliers may be paid at the end of the month, but payments from customers not received until the beginning of the following month. Capital expenditure programmes, taxation and dividend payments often result in lumpy expenditure patterns, and the cash outflows that they represent are offset fully or partly by the regular cash inflows from the company’s underlying business. Some companies have a seasonal business, with cashflows from the business being stronger at certain periods of the year.

This chapter considers the question of how the treasury function is managed and controlled. It examines the management of the function from the standpoint of the main board and chief financial officer as well as those internal controls that are necessary to achieve an efficient and secure treasury department. It addresses a number of questions that boards, chief financial officers and corporate treasurers are often asked: ‘Should our treasury department be a cost centre or profit centre?’ ‘How do we measure the performance of the treasury function?’ ‘Should we operate with a centralized or decentralized treasury function?’ ‘How should we manage our banking relationships?’ ‘Are there some treasury activities that could be outsourced?’

Treasury management systems (TMS) are essentially large databases of treasury transactions. They enable the treasury department to collect information on treasury transactions, and to facilitate the calculation and monitoring of positions and exposures by currency, maturity and type of instrument. In addition, they enable varying levels of analysis either based on the transaction detail stored or using decision support and modelling techniques.

In all the preceding chapters, treasury activities have been approached from the standpoint of economic value. Do the treasury activities protect the company from financial risk and do they add value to the organization? The question of adding value is usually tackled from the standpoint of reducing costs and giving greater certainty to cashflow and earnings numbers.