Cash management debate: How cash is driving working capital management

Cash management debate part one: How can cash managers add more value?

Cash management debate: Learn more about the panelists

Jack Large Let’s look at managing FX and commodity volatility. Perhaps we can start with those who have been struggling with the eurozone?

PP, easyJet One key point is to focus on natural hedges and the nature of your business, rather than reaching for the derivative solution every time. For example, we have discretion as to how we are billed. If a company is offering us sterling billing, chances are it is because its own treasury is making a turn on it. I try to make sure that procurement pay in the natural currency that the seller or the provider would like to receive. So although 44% of our €2.8 billion revenue is in euros, the net result is something under €500 million a year after we take into account euro costs. So we make sure that the teams involved understand the implications of their choices.

Jack Large This is picking up what Rajesh was saying: that increasingly treasury is getting involved in procurement and those types of tasks.

SC, AstraZeneca We have been working on this a lot in the past 18 months or so. We have a global procurement organization, which helps, but you still find odd historical practices. We report in US dollars, so to use an example similar to Paul’s, if we buy from, say, a European supplier, we are quite happy to take euro costs because we have a big euro revenue base. So we are working with the procurement teams on the key principles about what currencies they should be transacting in. For the basic ones, single currency is reasonably easy. It gets a bit more complicated when you get multiple jurisdictions and global supply groups. And to me, one of the easiest ways to manage your FX risk is to do this natural matching.

RaM, Citi In other words, both Paul and Sean look at the natural offsets first and then look at the residual, and finally, look at the basis risk and the correlations, and only hedge the delta.

Different approaches

LW, BAML Absolutely, the risk management strategy of treasury generally follows the business that the enterprise is involved in – in addition whether treasury is viewed as a profit or cost centre by its organization. Those that build or trade take a different approach to those that serve or make money from money. If you look at Google, its approach is innovative and very much speculative, and it can be due to its profile. A manufacturer, however, cannot be as speculative as it needs to have cash for use in its business. What is consistent is that risk management needs to be aligned closely with business strategy and consistently monitored to ensure it is meeting the end goal of the treasury.

RoM, Co-operative Our approach is straightforward. Once we have a contract in place and we have a currency exposure, we will hedge that exposure. All our operations are in the UK, – except that we have a joint venture in China – but we hedge when we have an unconditional contract in terms of having any exposure to manage. We have also become much more sophisticated in commodity hedging as we consume large amounts of electricity and gas – our annual electricity budget is between £50 million and £60 million – and we now put in place fixed-price contracts with the National Grid supplier in accordance with our predetermined hedging policy. We are the UK’s biggest farmer and we hedge the price of wheat in terms of fixed-price supply contracts with milling agents. This is the result of having a much better idea of how commodity and FX price volatility could hit the P&Ls of our various businesses.

VM, RBS Forecasting is the key to a successful hedging programme. We did a survey on cashflow forecasting and about two-thirds of the corporates that we spoke with couldn’t accurately forecast with confidence past 30 days from a liquidity perspective and had implemented fundamental changes to their treasury and finance operations to improve the accuracy and reliability. The same approach to forecasting is also required for FX risk management. What we are seeing is a more rigorous approach to cashflow monitoring and hedging – not just using those monthly rolling cycles that you get from the ERP budget and placing your forward or swap and letting it roll to maturity and then rolling it over. We are seeing much more of a discussion around the tenor and level of hedging; the accuracy of your cashflow forecast is clearly key to getting the right tenor. Post-crisis, one of the key success factors in the varying financial performance of peer corporates was the effectiveness of their hedging programmes.

We are also seeing much more willingness to look at options as an integral part of a hedging portfolio. This is not just because there is an increased level of comfort in the technology and accounting support that is available, it’s because the crisis tested the other forms of hedging to the limit. And the upcoming revisions to IAS39 and FAS133 will help this further.

DM, Barclays Our focus has traditionally been very short. We look at rolling monthly cycles and use short-dated forwards to close that risk. Does that mean that we are missing a trick on the bigger picture in terms of, say, the long-term patterns of commodity prices? What is the natural hedge in the long term against the cost of that input to a business? Is there a natural hedge for example on Asian consumption? I think that is where the market is heading, but we are not seeing significant activity yet.

PP, easyJet Clearly we have a big exposure to a single commodity – oil. What do we do about it? Well, what treasury does is driven by overall policy. You do sensitivity analyses and on that basis you decide a hedging policy. Then the trick is to apply it consistently over a range of outcomes.

RoM, Co-operative We use a fuel supplier for our logistics vehicles and they do the hedging as part of their purchasing power; that may or may not be the situation in future. The important thing in commodity hedging, as Paul says, is the basis risk and knowing exactly what underlying exposure is so that you get a pure hedge. And in many commodities you can’t nail that down. Obviously all the various tax regimes further cloud the issue on getting a perfect hedge. I am interested to hear Paul’s experience of that. Did easyJet achieve a perfect hedge in terms of their exposure to aircraft fuel?

PP, easyJet Clearly, because of IAS 39, we always try to ensure that we get hedge accounting treatment to minimize the impact to the P&L of volatility shifts. That leads you down a particular path, which as it happens is the right one. If we use jet fuel, we should be hedging jet fuel. The companies that component-hedge are locked into what was quite an attractive crude price but then came unstuck as they tried to move through the various derivatives to get them up to the full jet price. They swapped one risk for another one, which unfortunately didn’t go their way.

Working capital management solutions

Jack Large Can we change topic now and look at working capital management solutions and opportunities? Sean talked about cash as the new driver. So what can treasurers do to make sure they are on top of this?

RaM, Citi First, let’s remember where this comes from. The crisis has reduced the availability of funding and pushed up its price. Companies were therefore constrained to generating their own liquidity, rather than borrowing from traditional sources. This drove initiatives to optimize internal liquidity and companies turned their attention to releasing trapped cash.

The natural second step was then to actively generate increased liquidity. This meant looking at the DPO [days payable outstanding] cycle, the DSO (days sales outstanding] cycle and inventory. The problem has been that the people who manage those three processes have historically been driven on different metrics. Companies are now starting to change and harmonize those metrics and performance measurements.

Next we see reform of the supply chain. In essence, supply chains in which large companies buy from smaller suppliers have faced supply-chain disruption because the SMEs have been hurt a lot more than large corporates by the crisis. This was deemed so serious that governments set up liquidity and other facilities to support small businesses.

To date, a lot more has been done on the supply side, on the buy side, and less on the sale side. However, we are now seeing an increased focus on the sale side, especially by treasurers who have a large Asia component in their remit and are looking at sales growth.

Jack Large Sean, how do you optimize the balance between DPO and DSO and DIO [days inventory outstanding] and the financial supply chain? You can’t push all of them all at once. Do you see an optimum or are you looking for one?

SC, AstraZeneca For us it is about the stage in which you do them and not trying to do too much at the same time. Most of our focus has been on the purchase side; that is where you have more control and more opportunity. The first thing we had to do was establish the right process, so we look more at our P2P process with our P2P team because, for example, if you change your payment terms or you put some kind of supplier financing in place, you still have to be able to pay for those new terms. The second element, before looking at more sophisticated solutions, was to look at our current supplier set-up. So ask questions like: "Do we have different terms with the same company in different jurisdictions?" There are a lot of easy wins in simply tidying up the current process. The third stage, which we haven’t got to, is beginning to look more at true supplier financing. There is value here, but it has been pushed for a while and we are now seeing better solutions, better products and a better understanding of what corporates’ needs are. It is something that we may develop next year as there is an arbitrage opportunity on our funding costs as well.

RaM, Citi That last point is important. Before the crisis, it was true that for a lot of people, the arbitrage story was not compelling enough. Since the crisis started, however, it was not arbitrage, but supplier finance that became the only option for many businesses, thereby opening up the whole supply-chain financing opportunity.

SC, AstraZeneca Absolutely. There are a number of reasons to do it, but with arbitrage it becomes a lot more compelling. But you can’t go straight to the end without getting the basic plumbing right first and that has been where our focus has been to date.

RoM, Co-operative Our focus is making sure that we have single procurement across commonly sourced products across all of our businesses. On supplier finance, we are just in the process of implementing that, and going back to what was mentioned before, if you target the right suppliers and they can leverage off your credit rating it can be very attractive.

LW, BAML I think Sean’s comments were instructive. First you have to get the basics right. It is about recycling cash as quickly as possible, keeping lean. It doesn’t have to be complicated; often, the simpler the better. A bank’s role is to help make the treasurer’s life easier. To do this we need to see things from their point of view. It’s about the bigger picture not a siloed approach; it is understanding the company’s needs, then connecting up the dots.

Corporate challenge

VM, RBS The corporate challenge is breaking down the silos in the banks themselves, particularly around global transaction services and capital markets solutions. What you do see now is the harmonization of not just cash and trade processing, but also innovation around cross-currency and high-value payments and short-term investments.

Then yes, it is back to basics: look at invoicing and how you collect more quickly and securely. It’s not just about taking the paper out of the cycle, but also using the information in the invoicing cycle to give much more granular information about your customers and suppliers. And again, we can provide value-added analytics to identify trends that can drive targeted financing opportunities.

DM, Barclays One step back from supplier finance is simply the articulation of what the client wants out of a supply chain. That goes back to Sean’s comments about supplier terms. Is the client undertaking that evaluation? Is the corporate looking to aggressively manage suppliers for discounts and longer terms of trade? Are they looking to secure the supplier so that they have a ready source of supply? It is that background that needs to be worked on before we say: "We’ll move into supply-chain finance". It is not just the speed that cash goes round the system, but it is how you are managing risks around it, leakages in the system, automation, straight-through processing and so on.

SC, AstraZeneca I do believe that the key strategic element that treasury has affected is the supplier relationship and perhaps the customer relationship, because that is where we can create savings for the business through the way we finance that end-to-end chain. This is the biggest opportunity for treasury to genuinely change something.

RaM, Citi I agree. This business is on the cusp of a change. At the current interest rate levels, cash management banks will be looking to increase the fee component of their business model by expanding their services into areas adjacent to their traditional activities.

DM, Barclays On that point the treasury is increasingly becoming its own banker. There is a very healthy disintermediation in the future in lots of areas, a lot of the B2B, a lot of the C2C, bank in a box, "Just have one account with us, but otherwise you will have tens of thousands of your own customers transacting with you"; much easier, much simpler. The bankers still have their role to play but we are not having to intermediate or take risk on every single transaction that comes through the system. There are really healthy things going on in the future, in the retail, the corporate, the capital market space, where clients effectively do their own banking and we support and actively facilitate that.

Investing excess liquidity

Jack Large Paul and Sean, you both have cash that needs to be invested. How do you decide how to manage it? Sean, what do you do with $11 billion?

SC, AstraZeneca Well, this has its challenges as well. The key points for me are that, first, the cash needs to be available for use by the business and secondly we adopt a prudent approach to what level of risk we are willing to accept. As such, we don’t have much choice other than to invest it fairly short-term, in high-credit-quality instruments and accept the current low yields.

PP, easyJet One way to look at it is to say that the cash is the ultimate committed facility; it is readily available at short notice. Our main issue is FX risk. We have sterling cash, versus a floating dollar exposure. So we have converted a significant part of that cash into dollars specifically matched against the three- or six-month re-fixes of our debt. What we do with excess cash has been largely ratings-driven. So for a single-A bank, we won’t go out beyond a week. And we keep on top of developments with the banks. And, although it requires work, we do make use of money-market funds as their disclosure improves.

DM, Barclays From the banks’ point of view, the key is how to optimize corporate cash in this new environment. Clearly, to take Sean’s point, if you are that sensitive to ratings then you lose an awful lot of potential value because you move the money as soon as a ratings event is predicted. One way the market is evolving is to say: "How do we define this contractually short, but clearly behaviourally long money, because that has substantial value to a bank?" The Financial Services Authority is working with us collectively on guidelines but we are still short of concrete rules at the moment. The corporates want value for that behaviourally long money and banks are working on ways to give it to them in terms of yields or discounts elsewhere while maintaining instant access as far as possible.

Many of our compliance people are becoming increasingly front-line sales working with compliance departments to say: "What do break clauses look like? What does this account do in the event of certain market events?" and so on. At the moment liquidity buffers are there overtly as protection for the entire market, not just the client, to show that the bank has that safety net for everybody, that is where the money sits, but by definition it goes into gilts and short-dated instruments and the yields are substantially reduced.

RaM, Citi What we are starting to see is banks optimizing the liability side of the book. Two things are happening: the FSA guidelines and Basle III and the differentiation they make between a transactional balance and a wholesale balance, which will determine which products banks will have to emphasize.

Jack Large Roger?

RoM, Co-operative As a net borrower at the recent European treasurers’ conference in Geneva, it struck me rather that the banks, instead of saying: "These are all the value-added services that we can provide you with if we come into your debt syndicate", the message was much more: "Invest your excess cash with us; these are the vehicles that we can offer you; this is the copper-bottomed triple-A SPV that we have created to give you enhanced yield but reduced risk". So I’m not sure we need to go up the risk curve; the banks want corporates’ excess cash balances and will pay for them with competitive yields.

More complicated

VM, RBS I think for the banks it’s a little more complicated than that! Banks are currently working with regulators to individually and collectively assess the impact of numerous regulations including Basle III and, for example, FSA regulations around individual liquidity adequacy.

Short-term funds, unreliable cashflow forecasts and tough trading conditions together with an increased awareness of counterparty risk have caused treasurers to keep funds accessible, all but eliminating yield in the current low interest rate environment. Products are being developed that can reward tenor while ensuring funds are accessible, giving treasurers more options for investment.

For example, RBS has developed a new suite of account-based investment solutions that reward your operating cashflow as your business cycle and daily position dictates, with a bonus rate for stable balances over an agreed interest period as well as a basic rate for fluctuating balances over that same period. Other variations include account-based deposit solutions that pay term yields on funds based on the real-life behaviour of the core balance on the account.

As for money market funds, the big development is portal technology that enables treasurers to view and compare asset mixes to reduce that element of the workload. There are a lot of enhanced cash funds using longer-weighted average maturities offering enhanced yield and a triple-A rating.

RaM, Citi As the economy reverts to normalcy, banks will have more asset outlets for their deposits, which will help break the cycle.

SC, AstraZeneca I agree with that. We have always had a level of cash to manage but we have never seen our banks as places in which we invest. We have always seen other investment vehicles as being where we put our excess funds, and as such we tend to clear our accounts daily. We use money-market funds, we buy treasury bills and commercial paper. Through the crisis, other than banks that really want the money, which always makes you worried, generally there has been more of a pushback saying: "We don’t want your money, because if you give it to us, what are we going to do with it?"

PP, easyJet In terms of any desire to increase yield through increased risk, I don’t see that coming any time soon and certainly not for us.