With the first three articles in this series on treasury transformation, we’ve covered the process of taking stock of what’s happening internally, and the importance of benchmarking your firm against its peers. We’ve also discussed the value of incorporating marketplace trends and emerging technologies into your strategy. With this fourth installment, we examine options for improving visibility, efficiency and control by centralizing treasury functions.
At some point, growing companies inevitably come to the realization that they can’t or shouldn’t continue operating as they have been—what worked for a $200 million company simply isn’t effective in supporting the volume and operational requirements of a $2 billion company. Whether growth has been organic or the result of a merger or acquisition, firms should consider centralizing treasury functions to match the needs of their new corporate footprint.
However, centralization is not a panacea to all corporate treasury matters. In certain instances, a decentralized operating model will be better suited for local regulatory and business needs, market conditions and customer requirements. In other situations, the right answer may include hybrid arrangements where decentralized and centralized functions co-exist and complement one another.
Before deciding what’s right for your company, it helps to understand the range of centralization options and under which circumstances each will be most beneficial.
Companies focused on improving process efficiency typically look at shared service centers (SSCs). An SSC aggregates defined activities that were previously managed locally and separately in each legal entity or line of business—such as accounts receivables, payables, reconciliation and payroll—and co-locates or centralizes them in a single team or structure. Personnel on these teams are solely dedicated to completing the tasks of a specific function across the entire organization, thus allowing companies to standardize processes and realize economies of scale. The efficiencies of an SSC come from maximizing the productivity of each employee; positioning the company more favorably with suppliers, banks and other vendors; and facilitating change efforts across the organization through the unified setup.
When setting up an SSC, a single enterprise resource planning (ERP) environment is ideal but not required. In multi-ERP environments, it may be preferable to have a dedicated staff that’s cross-trained on all your ERPs to accommodate the process variations, or subteams that are specialized in individual ERPs on a potentially rotating basis. Location also matters when finding the most desirable mix of low-cost location, pools of skilled labor and a favorable time zone.
For companies that have traditionally relied on local country offices to manage cash but now seek greater control over and access to both cash and information, a regional treasury center (RTC) is a logical choice. Where an SSC focuses on cash operations like accounts receivables and payables, an RTC is, as the name implies, treasury-focused. It’s an in-region extension of the headquarters’ treasury and links with local operating units. An RTC often acts as a center of expertise instead of just an operational hub, giving the overall company improved control of global accounts and balances.
RTC personnel typically report directly to corporate treasury to ensure efforts are coordinated and knowledge is shared throughout the organization. While staff expenses are unlikely to decrease, as they typically do with SSCs, an RTC often adds or re-allocates in-region staff to provide a more holistic strategy to the region’s liquidity needs and management. Ultimately, an RTC would help optimize cash utilization while boosting yields on balances and actively managing risks, and also deliver a more cohesive bank relationship strategy overall.
A step past an RTC is an in-house bank (IHB). An IHB goes beyond the functional consolidation of treasury to create a single, legal entity that holds the corporation’s balances and manages its market-facing exposures. As a central holder of balances, an IHB enables a company to self-fund across multiple locations with cash available at the group level, thus reducing reliance on external funding sources.
Better management of foreign exchange is another key benefit of an IHB, as a company can take a portfolio approach to its currency holdings rather than making one-off foreign exchange trades at a local entity level. Depending on the level of sophistication, this is often combined with more efficient netting capabilities. This allows IHB participants to offset positions bilaterally, with the IHB as a central counterparty, instead of multilaterally, spread out across the organization and external trading partners.
However, these benefits don’t come easily to a decentralized organization. The effort to set up an IHB requires close coordination with senior management outside of treasury, such as those in financial planning and analysis, and its objectives have to be closely aligned with those of the overall company. An IHB structure requires significant legal considerations and carries ongoing tax consequences all the way through to client-facing units like sales, especially when run as a profit center.
An on-behalf-of (OBO) structure or payment factory is one of the most advanced centralized structures in the market today. This framework combines the functional efficiency of an SSC with the strategic liquidity focus of an IHB. In an OBO, the IHB entity not only holds the cash balances of all allowed participants in the company, but also transacts payments and receipts on behalf of the local entities. In this case, participating local entities will no longer hold operating accounts in their name (with some exceptions due to local requirements) but instead will use the IHB entity’s physical bank accounts to transact with their vendors and customers and an internal subledger to track their overall cash position.
As a result, the key benefit of the OBO structure is that it vastly reduces the number of accounts the organization holds globally, depending on the number of participating entities. That said, not all entities may participate in an OBO structure; regulatory and tax considerations in its country of domicile largely determine an entity’s ability to participate in a complex structure, so your internal tax and legal colleagues will have to weigh in on the setup.
In addition to these externally driven considerations, the single biggest obstacle in a group of companies is tracking and managing intercompany positions, so it’s typically most effective and realistic in a single ERP environment. At this stage, companies can also take advantage of XML file formats and virtual structures to run and optimize the configuration.
Choosing to centralize treasury is about finding the right fit for your organization. With time, and given the dynamic nature of a growing multinational footprint, your approach to centralization may also need to be revisited. What is scalable today may no longer be at a later stage.
While agile is a term derived from software development, it can also be applied to a living and breathing treasury organization. Don’t try to go all the way in one go. A phased approached with the buy-in of top corporate executives, local management and affected employees will lead to greater acceptance, a more solid setup at each step and, ultimately, a successful implementation.
To determine the optimal structure for your organization, it helps to work with a bank and vendors whose other clients have traveled down this path before you and tap into their lessons learned. They are often supportive and even willing to put you in touch with your counterparts at these companies. Their insights into implementing new treasury structures, along with the successes and challenges experienced along the way, can be invaluable to evaluate options for your organization.
Internal communication is also crucial. Obtaining and reviewing input from your stakeholders—operating entities, legal, tax, IT and others—is vital in determining not only the appropriate treasury structure for today, but also for where your organization will be tomorrow.