Treasury: The Ideal Function to Centralise
When a corporate builds a treasury unit, it is effectively centralising the processes that are managed locally. There is little impact on the core business of the subsidiaries – headquarters is merely lifting and shifting treasury processes to a central location.
There are three reasons why treasury is an ideal function to centralise. First, a centralisation project can have quite a high financial impact, which means the business case is strong, and a quick payback time, usually between six months to a year. Second, there are also a number of qualitative benefits to add to the business case, which may be hard to attribute a value figure to but are important in the overall efficiency and quality drive. And the third reason is that it doesn’t require a huge investment.
Although some companies may choose to put in place a treasury management system (TMS), which could require a large initial investment, many mid-sized corporates start by using basic Excel spreadsheets. When they reach a critical mass in terms of volumes, they can invest in a TMS. However, there are many things a corporate can do to centralise treasury functions before it moves to a TMS.
Why Centralise Treasury Processes?
It is important not to look at centralisation as a goal in itself, but explore the benefits it will bring as part of an overall business vision.
The five main benefits to be gained from centralising treasury are:
- Allows subsidiaries to focus on core business, without having to worry about loans and managing liquidity, etc (i.e. treasury can draw a clear line between treasury activity and activity managed by a subsidiary).
- Allows cash or liquidity to be viewed as a corporate asset. This proved to be extremely important during the financial crisis – a company must have control over its liquidity in order to manage its payment obligations.
- Allows for an enterprise-wide view of risk exposure. A corporate must manage risk centrally in order for it to be efficiently controlled and mitigated.
- Allows funding to be handled in one location. In a tight credit environment, it is difficult for a subsidiary to obtain a loan if the bank doesn’t have a relationship with the parent company.
- Allows for economies of scale, which is important to reduce costs as well as to be able to grow organically or through acquisitions without having to add additional treasury resources.
There are also potential negative aspects to centralising treasury, such as reducing local competency with regards to financial issues, but these need to be weighed up against the benefits and actively mitigated.
Best Practice in Centralisation
There is no treasury centralisation model that fits all companies, because all are different in terms of organisational structure and culture, plus they operate in different industries, and across different countries and currencies, etc. For example for a Swedish company that trades across Europe and buys some materials from the US, the biggest flows will be made up of three currencies – the euro, Swedish krona and US dollar – on which it will base its treasury processes. Therefore, each company should do an initial analysis on currencies, but also needs to understand the geographical markets that it is active in.
The company’s treasury structure is also dependent on the structure of the company:
- Is it a purely domestic player or is it international?
- What is its profitability? What is the balance sheet like?
- Is it selling to consumers (B2C) or businesses (B2B)?
- What industry is it in and in which markets?
- What type of products is the company selling and at what terms?
- What is the supply chain structure?
- Where is the supply base?
- How is it selling its products?
- What is the level of intercompany trade?
- Where are the production units?
- What do the internal or external cash flows look like?
- What is the legal structure?
- How many banking relationships does it have?
- What treasury/enterprise resource planning (ERP) systems are in place?
- Does the company have a global ERP system or is it a fragmented IT structure?
Another important consideration is company culture. For example, there are many companies that are decentralised and where that is a natural component of their business model. What is the size of the company and how many treasury staff does it have? Does the level of staff proficiency allow it to centralise?
A company needs to consider all the above before setting up a treasury. It also needs to define the role of treasury so that it has a vision of the value treasury can deliver to the organisation.
As a finance manager or treasurer at a mid-sized corporate, it is important to look at what your peers in the same industry are doing in order to find similar good/best practices. A corporate should also tap into the wealth of knowledge that its relationship banks hold regarding different customers in different stages of treasury evolution. Therefore, a first step is to find information outside your own company and learn from others before deciding on a vision and structure.
Stages of Centralisation
Before embarking on a centralisation project, it is critical to have the vision, strategy and policies fully supported by the board and top management. A structured process is key when it comes to establishing a treasury, in order to be able to present an attractive business case and get top level buy-in from management.
Every company is unique and begins the process at different points, so a centralisation programme should be seen as an evolutionary process.
There are four stages of centralisation:
The first phase is to concentrate liquidity that lies in local bank accounts. At this point, the corporate should keep its local banks, since there is an established relationship and it can be an effort to switch banks. Instead, sweep the cash into centrally managed bank accounts or centralised banks. That can be done on a weekly or a monthly basis, in order to concentrate liquidity and gain control over cash.
The second phase is to further centralise liquidity by using the same bank locally as centrally. For example, a Swedish company could set up a pan-European solution with an automatic cash concentration solution with domestic and cross-border, multi-currency cash flows, in order to manage liquidity more effectively.
At this point, a company should also put in place cashflow forecasting in order to be able to manage short-term funding and investment, as well as foreign exchange (FX) exposure. Hedging can also be centralised once the cashflow forecasting is in place. In addition, a company could put in place an inter-company netting system, particularly if there are large internal flows between subsidiaries and treasury, or between production units. Long-term funding is also something that should be managed centrally, together with the interest rate risk exposure.
At this stage in the centralisation project, mid-sized corporates should consider outsourcing because they may not have the scale or investment needed for establishing a fully centralised treasury. Outsourcing could be a cost efficient and flexible option. In addition, outsourcing can establish industry best practices and gain economies of scale by sharing personnel and systems with other companies.
It is time to go one step further, going beyond traditional treasury activities and into centralising incoming and outgoing payments. Trade finance handling, letters of credit (LCs) and documentary payments, normally handled within the purchasing or sales department, can also be centralised at this point. To centralise outgoing payments, a company should set up a payments factory; whereas a shared service centre (SSC) can be created to centralise complete handling of accounts payable (A/P) and accounts receivable (A/R), including incoming and outgoing payments. Although these areas are not normally part of treasury, they could have a very important role to play here since the selected set-up will have an impact on treasury operations.
The final phase is based on expanding the role of treasury so that it becomes more of a business partner for other activities. This can involve moving into advanced risk management, such as commodity, credit and operational risk. The treasurer should be a driving force when it comes to improving working capital management (WCM) within the company, taking on a strategic capital structure work, managing credit risk, and directing customer and subsidiary financing projects. In the long term, a treasurer’s role could expand to manage insurance, real estate, pensions, investor relations, tax, and mergers and acquisitions (M&A), for example.
The Business Case
Some reasons why centralisation is not currently happening were discussed in ‘Centralisation – The Eternal Trend?’, but it is worth reminding ourselves of the main points:
- Resource constraints in treasury and other adjacent parts of the organisation.
- A w eak treasury mandate resulting in poor understanding and response from business units and other units outside treasury.
- A lack of communication and common goals between different parts of the organisation.
- Many, differentiated and increasing responsibilities, put on treasury over time,has resulted in a catch-22 scenario, where being stuck in an obsolete or inadequate system environment leads to cumbersome manual processes, adding to workload and operational risk.
- Treasury is a business support function (not core business), resulting in inadequate top management attention and unwillingness to invest in necessary technology.
- Difficulties in arguing a good enough business case compared to other types of initiatives.
It is important to have a structured process when it comes to establishing a centralised treasury, and a finance director needs to present an attractive business case to the management board. Although this may be difficult because treasury is generally viewed as a support function, a structured process can get finance directors past common hurdles.
It is also essential to look into the characteristics of the company and conduct a practical current state analysis of the business vision, risk exposures and cash flows. Doing this groundwork makes it easier to create a business case that the management board will listen to.
The business case is made up of quantifiable benefits, but there are also qualitative aspects that are important but difficult to assign a value to, such as compliance, quality, increased security, and improved transparency across the business. The quantitative parts of the business case can be divided into cost/income, working capital, risk management and capital structure (see Figure 1).
Potential Benefits and Costs of Treasury Centralisation
The following benefits and costs can come about by transforming the treasury operation at stage two of centralisation:
The business case can be based on benefits gained from more efficient processes, economies of scale and lower costs, such as reducing fees, float, internal transfer costs, number of local treasury full-time equivalents (FTEs), etc. For example, a pooling solution may generate higher fixed costs but a corporate would be able to reduce the number of banks it uses in addition to the benefits gained through an improved interest net. By setting up a netting procedure, a corporate can reduce the internal transfers and FX transactions by netting the different flows. It could also channel internal flows through the cash pools.
Centralising risk management will result in great information transparency, which will lead to better control. The corporate will also be able to centralise its FX management, thereby reducing the spread and fees for FX transactions and create opportunities for natural hedges. In addition, by reducing FX risk it will reduce unnecessary losses as a result of FX volatility.
By centralising and improving its external short-term and long-term funding programmes, a company will get better terms, in addition to receiving higher interest on short-term investments.
When looking at the total cost base for running centralised treasury operations, there are usually two significant costs: the average personnel costs account for 75%, while systems and other administrative costs make up the remaining 25%.
At a mid-corporate level (with a turnover up to €1bn), a normal treasury is made up of between one and four FTEs, but treasury staffing levels differ by treasury sophistication, industry type and company size. Personnel are normally split between front, middle and back office in order to segregate duties and improve internal control, or at least a front and a back office if it has less than three FTEs.
When putting in place a TMS there are also taxes and legal, as well as project related, costs (e.g. consultancy).
Looking only at the quantifiable benefits and costs, centralisation normally results in a payback time of between six months and a year in most cases. In addition, there are qualitative benefits that can be realised, e.g. improved compliance, security and control, access to consolidated information (e.g. risks and liquidity) and access to highly skilled/knowledgeable treasury personnel on a central level for subs/management to draw on.
Factors to ensure a successful treasury centralisation project are:
- Clear vision supported by the top management.
- Thorough understanding of the underlying business.
- Standardised policies.
- People with the right set of skills and experience – a consultant can be used as a facilitator.
- The recruitment of a group treasurer.
- Transparent and clear communication – internally and externally.
- Short project cycle time – fast and clear decision-making.
- Timely recognition of tax and legal issues.
- The ability to listen but prepared to take tough decisions to convince local managers.
- Performance measurement – reporting, control and follow-up.
- The use of success stories as ‘proof of concept’.
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