Companies are focusing on cost reduction to counteract anemic earnings in a prolonged period of slower global economic growth. Driving efficiency presents a tremendous opportunity for treasury professionals looking to contribute to this effort. The challenge is how to marry efficiency with sound treasury management as organizations become increasingly diversified globally.
Many treasury professionals are overcoming this challenge by providing their companies with strategies and solutions that provide the benefits of centralized cash management—which supports objectives such as cash visibility and the facilitation of business at the local level—but don’t require changes to the corporate structure.
Forces of Inefficiency
Global expansion introduces complexity and fragmentation, which can easily lead to inefficiency that negatively affects the balance sheet and income statement. Costs increase across bank accounts, payment and foreign exchange (FX) fees become bloated and funding costs rise. Suboptimal management of liquidity and working capital also cost companies. Drivers of inefficiency include:
Organizational. Isolated liquidity pools form as legal entities work with multiple banks across the world. This obscures the cash picture and mitigates treasury’s control. M&A and its accompanying integration issues and the use of manual, non-standard processes can exacerbate the issue.
Technological. Often companies manage multiple databases and enterprise resource planning systems and support numerous proprietary electronic banking platforms across their banking network. A lack of data and communication standards is common.
Environmental. Companies also must contend with the accelerating pace of technology innovation and adapting to it in a quickly changing, global landscape. This includes rapidly evolving payment systems and the introduction of new payment methods. Differences in payment system requirements within and across markets heighten complexity.
Regulatory. All of this plays out across different legal and tax jurisdictions with varied degrees of freedom or restriction of capital, bank accounts, cash movement and regulatory reporting. Treasuries have to contend with this patchwork landscape amid the global trend of increased regulation following the financial crisis, exemplified by Basel III, with new, expensive requirements for monitoring, compliance and reporting.
Solutions for Efficiency
So how are companies gaining efficiency without a major organizational overhaul? Many treasuries are working to effect change on three levels: 1) accounts and liquidity, 2) efficient transaction execution, and 3) solutions that balance strategic and tactical requirements.
Accounts and liquidity
As companies expand their geographic footprint, local entities open acounts in operating and non-operating currencies. This creates the first layer of fragmentation. As an offset, treasuries are optimizing currency flows and liquidity across their organizations by:
Streamlining account structures. Companies are employing a single set of accounts for paying and receiving in multiple currencies from a centralized location or locations with competitive cut-off times. The account structure supports faster, more efficient liquidity consolidation and allows for self-funding, natural hedges and optimization of excess cash.
Centralizing currency flows. Home currency centralization goes one step further by placing a company’s bank account for its home currency in one geographic location with a single bank and then making and receiving all payments from this single account.
Overlaying liquidity structures. To maximize the value of operating liquidity, companies are combining centralized account structures, accounts aligned across time zones and accounts that embed FX capabilities to create seamlessness for cash visibility and mobility. These are blended with liquidity products to mobilize funds and currency positions and optimize interest earned by virtually recognizing combined balances across currencies, locations and account owners.
Efficient transaction execution
It costs €20 billion annually to fix business-to-business payment errors in Europe alone, not including the price of investigating delayed or missing payments1. Cost contributors include payment methods (e.g., wire versus low value) and lifting fees imposed by intermediary banks. Slower payments, disassociated information flows and lack of payments visibility impede the management of cash, liquidity and working capital.
Strategies and solutions to lower payment costs and improve timing include:
Maximizing book transfers. One strategy is to maximize the use of book transfers rather than wires or low-value payments. Given that the U.S. dollar remains the leading currency for payments globally, banks that lead in dollar payments volume—and that maintain the largest correspondent banking networks—can deliver a higher percentage of book transfers. This lowers a payment’s base cost and eliminates lifting fees from intermediary banks.
Lowering repair rates. A bank’s U.S. dollar leadership position can significantly lower the repair rate and payment cost by more effectively performing pattern analysis on substantial transaction volume and applying artificial intelligence to automatically repair payment instructions prior to execution. Key to payment cost reduction and accuracy is a bank’s ability to proactively alert clients to continual market changes that affect payment formatting.
Integrating FX payments. An integrated approach to payments and FX that builds on a multicurrency account structure enables companies to increase book transfers and apply repair services across operating and non-operating currencies.
Using specialized solutions. Banks with global reach may have specialized solutions to accelerate payments in some markets. For example, in China, delays occur when Chinese banks transfer payments from the head office account to a beneficiary’s branch account. Leveraging a direct clearing link with Hong Kong’s Clearing House Automated Transfer System payment system shaves days off payments by directly crediting beneficiary branch accounts with major Chinese banks.
Gaining efficiency through scale. In-house banks, regional treasury centers, payments factories and shared services centers are part of a heightened focus on cost, efficiency and risk management. Companies are using such structures for economies of scale, working capital optimization amidst capital scarcity, and process improvement. Pay on behalf of (POBO) or receive on behalf of (ROBO) structures are a common model for gaining scale efficiency. POBO enables one entity to pay suppliers on behalf of another group entity. ROBO enables the concentration of all receivables traffic to a single legal entity, which accepts payment from counterparties on behalf of other group entities. POBO/ROBO structures leverage standard formats and uniform reconciliation procedures, enabling the use of fewer bank accounts.
Balancing strategic and tactical execution
Solutions that balance corporate treasuries’ concern for strategic execution with the requirements of legal entities for tactical execution are a key area of focus. At the tactical level, these solutions provide standardization and automation that simplify and facilitate business flow. At the strategic level, they enable enterprise-wide cash visibility, risk transparency, control and liquidity optimization. This allows corporate treasuries to manage cash more efficiently as a whole than its parts would be able to do.
Cash Flow Efficiency
FX management is an area where the bridging of strategic and tactical execution is imperative to financial performance. S&P 500 companies generate 60% of their earnings from international sources2. These companies are falling short of earnings estimates when overseas operations are tied to a strong U.S. dollar, which underscores the effect of currency exposure on profitability.
Corporate treasury professionals are bringing together strategic and tactical execution for FX by:
Using integrated platforms. Solutions that bring together one platform for execution with tools, resources and expertise for optimizing FX payments and hedging enable a cohesive approach.
Consolidating FX flows. Companies are recognizing that they may underestimate total currency exposure because of a lack of risk transparency around non-hedged transactions that fall below a notional dollar threshold (typically U.S. $1 million per trade). They are consolidating their FX business across large currency positions and small FX payments to increase risk transparency that supports a comprehensive hedging strategy. The approach also enables corporate treasury to negotiate consistent FX rates globally and apply flexible FX rate options.
Netting gross flows. A consolidated view of gross FX flows enables companies to leverage bank capabilities to analyze FX activity and increase netting across total transaction volume. This improves payment settlement timing, lowers costs and improves liquidity.
Corporate treasury professionals are working with their banks to tackle the complexity associated with global treasury management. Readily available solutions can enhance efficiency operationally and on the balance sheet. Balancing strategic and tactical execution is critical to success, so you may want to work with your banking partner to find opportunities to improve the bottom line.
1. New Euro Rules Expose Business to €20 Billion Payment Bill, Experian.com October 2, 2012
2. Bloomberg, FactSet, October 2013