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A Primer on Treasury Management

Ben Verschuere

Introduction

Treasury management could be considered as 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 profitably. 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 to his Egyptian counterpart the modern day treasurer is in charge of all the matter related to cashflow for corporation. The treasury management general goal 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 such analogy the treasury department act 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 good understating 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 with different banks. This makes it hard 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 and 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 for this task is to first being able to properly model those cash flows then use intelligence around it 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 in surplus of cash the first direct step is to look at what might be the best use of the excess of liquidity. As we can see below there are different options available. A treasurer expertise can help identify which might the be the optimal one. This choice will change on a company basis as well as through time.

Idle cash management: A first option available is to deploy the excess cash in financial instrument generating a yield providing 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 term 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 possible completely 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 be facing is falling short on cash to continue its operation. The company treasurer can decrease this risk via carefully monitoring bank accounts and providing cashflow forecast as well as via creating a reserve account which will help the company navigating 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 start rising to due to some price pressure in the commodity markets. The treasurer having identified such reliance can put in place some hedging mechanism to smooth out that risk.

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

Interest rate: Many companies rely on debt to finance themselves. A move higher 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 those currencies can then affect the finances of a company involved in business overseas. Again here the treasure can flag those risks and put some hedging program in place to minimize those fluctuations.

Operational Optimization

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

By breaking down the ROE into these components, we can see how that 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 many different tools it can deploy to optimize cash flows which ultimately increase the bottom line of a company. Furthermore the treasurer is also there to mitigate the financial risk a company might face and so very much increasing its resiliency.

Not only having a strong treasury department helps preventing financial risks which can be fatal for a company but it also there to improve 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

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