A Primer on Treasury Management

Stack of coins surrounded by pens
Treasury
Ben Verschuere - Chief Investment Officer
|
September 8, 2020

Introduction

Treasury management is arguably the least known function and the most underrated department inside a corporation. But its impact can affect all departments and most importantly when used well it can significantly improve a company's profitability. For example, according to a Bloomberg piece: "Airbnb treasury department represented 30% of the company revenue and generated more than $5Million a month [in 2018]"

The term Treasury comes from the Latin regions and southern Europe (Spanish, Italian Tesoreria – thesaurye, thresaurie - French trésorerie, "treasure house"). Treasury management isn't a new function; we can find its roots in ancient Egypt with the "Imy-ro khetenet" in Egyptian meaning "Master of the Seal". This Egyptian treasurer controlled the chamber containing the gold and silver and was Master of the Seal. Specifically he controlled all the reserves and the stores of products (beside food), which were controlled by the vizier (1).

Much like his Egyptian counterpart, the modern day treasurer is in charge of all the matters related to cashflow for corporations. The general goal of treasury management is to plan, control, and optimize cashflow to satisfy the financial objectives of a company.

Different Functions

Cash and more generally cash flows can be seen as the blood of a company. Using this analogy the treasury department acts as the heart of an organization. Centralizing and overseeing the intake and supply of cash flow around the entire organization. Given this it isn't surprising that treasury management has many different responsibilities within a company.

Liquidity Management

While having a robust understanding about the amount of liquidity a company has might sound simple it tends to be more complicated in practice. Often companies have multiple different bank accounts and sometimes companies bank with multiple banks. This makes it difficult to have a clear understanding of their current level of liquidity as well as where it is stored on a daily basis. Here the goal of the treasurer is to supervise those accounts and have a strong grasp about where the cash is.

Cash Flow Forecasting

The next step for the treasurer is to start looking ahead to understand how cash flows are expected to evolve in the future. This task is a highly complex one as it deals with inflow and outflow money coming in and out from many different departments and counterparts. Nonetheless this task is crucial to make sure a company will not lack resources in the future. The first step is to be able to properly model cash flows then use intelligence around these to be able to forecast them accurately.

Cash Management / Fund Transfer pricing

After having a good understanding of the cash flow dynamic of a company the treasurer can start using this knowledge and information to help the company make the best use of its available resources.

Within this function, the treasury department can be seen as a bank within an organization which decides where to best deploy the excess of cash and find the optimal way to finance its operations.

A. Investing:

For a company with a surplus of cash the first direct step is to look at what might be the best use of the excess liquidity. As we can see below there are different options available. A treasurer's expertise can help identify which might be the optimal one for their company. This choice invariably will be different across companies and may also change within an organization over time.

Idle cash management: A first option available is to deploy the excess cash in a financial instrument generating a yield that provides a return on that idle cash.

Forward pricing: Instead of directly deploying its excess liquidity in the capital markets a company might choose to use it to pre-pay some of its suppliers at a discount.

Lending / Credit Management: Another way of using its excess resources is for a company to provide some credit to its customer.

B. Financing

Another part of the treasurer work relates to overseeing the way a company finances its long term and short term operation needs.

Long term (credit): Companies can either finance themselves through equity or debt. Here, an important aspect of the treasurer’s work is to make sure future revenue will match with the maturities of the borrowing incurred. In technical terms this is done via matching the asset and liability (Asset/Liability Management) of a company and making sure those happen at the same time.

Short term (AR/Inventory financing): In the shorter term financing can be done via collateralizing loans with either the company inventory or its accounts receivable.

Risk Management:

Companies face many different risks. While it is never entirely possible to remove those risks the treasury department is there to identify them ahead of time and help mitigate those.

Liquidity/Solvency: The most direct risk a company might face is falling short on cash to continue its operation. The company treasurer can decrease this risk by carefully monitoring bank accounts, providing cashflow forecasts and creating a reserve account which will help the company navigate more difficult times.

Commodity: Many companies are reliant on commodities input to produce their goods. A key risk they face is when the price of those inputs starts rising due to price pressure in the commodity markets. The treasurer having identified such reliance can put hedging mechanisms in place to smooth out that risk.

Supply chain: Another risk a company can face is linked to a supply chain disruption (either due to natural disaster, politics or disruption). The treasurer can identify these by analyzing the cashflow and flagging an overly concentrated supply chain ahead of time.

Interest rate: Many companies rely on debt to finance themselves. An increase in interest rates can inflate its funding cost. The treasurer can be proactive about this by either moving forward or delaying the borrowing decision as well as putting hedges in the financial markets.

FX: Often companies deal with suppliers or customers purchasing their goods in a foreign currency. Movement in these currencies can then affect the finances of a company involved in business overseas. Here the treasurer can flag these risks and put a hedging program in place to minimize these fluctuations.

Operational Optimization

All the treasurer functions above can then be viewed in terms of optimizing the company's financial operations. Another way to look at this in a more explicit way can be done by using the Dupont analysis which breaks down a company's Return on Equity (ROE) as follow (3, 4):

By breaking down the ROE into these components, we can see how a treasurer can contribute to each of them:

  1. Net Profit Margin (Profit/Sales): Finding cheaper borrowing costs increases contribution margin = more competitive
  2. Asset Turnover (Sales/Assets): Improving the yield of assets through ALM and portfolio management = more revenue
  3. Financial Leverage (Assets/Equity): Managing debt to optimal levels = more opportunities

This shows how a well tuned treasury department can help improve the financial efficiency of a company in a many different ways.

Conclusion

As we can see the role of the treasury department is broad and touches on many different aspects and departments of a company. The treasurer has a variety of tools it can deploy to optimize cash flows which ultimately increases the bottom line of a company. Furthermore the treasurer is also there to mitigate the financial risk a company might face thereby increasing its resiliency.

A strong treasury department not only helps to prevent financial risks which can be fatal for a company but it also improves margins. This is how a cost center turns into a revenue generator...

Reference

(1) The origins of modern corporate treasury management

(2) Amazon.com: Treasurer's Guidebook: A Practitioner's Guide...

(3) Treasury Is the Most Underrated Team in Your Company

(4) DuPont analysis - Wikipedia

Ben Verschuere

Chief Investment Officer

Treasure Investment Management, LLC

Disclaimer: The views and opinions in this piece are just the author's own, offered to the public at large and not to any one particular investor.

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