Cash management debate: How cash is driving working capital management
In the second part of Euromoney’s cash management roundtable, the participants look at the effect of volatility in foreign exchange and commodity prices and how new products are giving treasurers more investment options.
• Treasury is increasingly involved with payment
• Treasuries’ risk management strategies follow the business the company is involved in. Different approaches result
• Cash is the new driver of working capital management solutions and opportunities
• Treasuries are increasingly becoming their own banks
• Post-crisis new products are being developed to give treasurers more investment options
Jack Large Let’s look at managing FX and commodity volatility. Perhaps we can start with those who have been struggling with the eurozone?
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.
"The crisis has reduced the availability of funding and pushed up its price. Companies were constrained to generating their own liquidity, rather than borrowing. This drove initiatives to optimize internal liquidity and companies turned their attention to releasing trapped cash"
Rajesh Mehta, Citi
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.
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.
"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"
Paul Philips, easyJet
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.
“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”
David Manson, Barclays
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.
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.
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.
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.