Financially Yours

Placement
Preparation
Primer

Treasury Management

A Primer on Treasury Management

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Treasury Management

Treasury Operations, Treasury Management, Corporate Treasury, Group Treasury- the names
might be different but all mean the same.

Treasury management could be considered as the least known function and the most
underrated department inside a corporation. But its impact can affect all departments and
most importantly when used well it can significantly improve a company profitably

In simple terms what does the Treasury department do?

Treasury is like a bank function inside the organization. It manages and holds cash and highly
liquid assets. Treasury is the backbone of any firm ensuring it wouldn’t fall over in times of
economic or financial uncertainty and that it has enough funds on hand for managing their
activities.

Treasury generally consists of Asset Liability Management (ALM) team which is the first line
of defense and Risk Management team which is the second line of defense

ASSET LIABILITY MANAGEMENT (ALM)

ALM concerns the blend of assets and liabilities that sit on a balance sheet and the subsequent
mismatches between tenor, currency, and interest rate (cost). Companies hold a range of
instruments on balance sheets, which behave with varying characteristics.
ALM is most relevant for treasury management in banks because their fundamental purpose
is based upon the gearing dynamic of borrowing and lending money. The graphic below
demonstrates generic balance sheet compositions for corporates and banks.

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Liquidity Management
Often companies have multiple different bank accounts and sometimes with different banks.
This makes it hard to have a clear understanding of their current level of liquidity as well as
where it is stored on a daily basis. Here the goal of the treasurer is to supervise those accounts
and have a strong grasp about where the cash is.
Cash Flow Forecasting
The next step for the treasurer is to start looking ahead and how cash flows are expected to
evolve in the future. This task is a highly complex one as it deals with inflow and outflow
money coming in and out from many different departments and counterparts. Nonetheless
this task is crucial to make sure a company will not lack resources in the future. The first step
for this task is to first being able to properly model those cash flows then use intelligence
around it to be able to forecast them accurately.
Cash Management / Fund Transfer pricing
After having a good understanding of the cash flow dynamic of a company the treasurer can
start using this knowledge and information to help the company make the best use of its
available resources.
Within this function, the treasury department can be seen as a bank within an organization
which decides where to best deploy the excess of cash and find the optimal way to finance its
operations.
A. Investing:
For a company in surplus of cash the first direct step is to look at what might be the best use
of the excess of liquidity. As we can see below there are different options available. A
treasurer expertise can help identify which might the be the optimal one. This choice will
change on a company basis as well as through time.
Idle cash management: A first option available is to deploy the excess cash in financial
instrument generating a yield providing a return on that idle cash.
Forward pricing: Instead of directly deploying its excess liquidity in the capital markets a
company might choose to use it to pre-pay some of its suppliers at a discount.

Lending / Credit Management: Another way of using its excess resources is for a company to
provide some credit to its customer.

B. Financing
Another part of the treasurer work relates to overseeing the way a company finances its long
term and short-term operation needs.

Long term (credit): Companies can either finance themselves through equity or debt. Here,
an important aspect of the treasurer’s work is to make sure future revenue will match with
the maturities of the borrowing incurred. In technical term this is done via matching the asset

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and liability (Asset/Liability Management) of a company and making sure those happen at the
same time.

Short term (AR/Inventory financing): In the shorter-term financing can be done via
collateralizing loans with either the company inventory or its accounts receivable.

Risk Management:
Companies face many different risks. While it is never possible completely to remove those
risks the treasury department is there to identify them ahead of time and help mitigate those.

Liquidity/Solvency: The most direct risk a company might be facing is falling short on cash to
continue its operation. The company treasurer can decrease this risk via carefully monitoring
bank accounts and providing cashflow forecast as well as via creating a reserve account which
will help the company navigating more difficult times.

Commodity: Many companies are reliant on commodities input to produce their goods. A key
risk they face is when the price of those inputs starts rising to due to some price pressure in
the commodity markets. The treasurer having identified such reliance can put in place some
hedging mechanism to smooth out that risk.

Supply chain: Another risk a company face can be linked to a supply chain disruption (either
due to natural disaster, politics or disruption). The treasurer can identify those by analyzing
the cashflow and flagging ahead of time an overly concentrated supply chain.

Interest rate: Many companies rely on debt to finance themselves. A move higher in interest
rates can inflate its funding cost. The treasurer can be proactive about this by either moving
forward or delaying the borrowing decision as well as putting hedges in the financial markets.

FX: Often companies deal with suppliers or customers purchasing their goods in a foreign
currency. Movement in those currencies can then affect the finances of a company involved
in business overseas. Again, here the treasure can flag those risks and put some hedging
program in place to minimize those fluctuations.

FAQs:

What is liquidity risk? How do you manage it?

Liquidity is the ability of a firm, company or individual to pay its debt without suffering losses.
Conversely, liquidity risk stems from the lack of marketability of an investment that can’t be
bought or sold quickly enough to prevent losses.

Liquidity management is the ability to meet cash obligations without incurring substantial
losses. A liquidity management strategy means your business has a plan for meeting its short
term and immediate cash obligations. It means your company is managing its assets including
cash to meet all liabilities, cover all expenses and maintain financial stability.

Factors that may increase liquidity risk- poor cashflow management, unplanned capital
expenditures, seasonal fluctuations in revenue, business disruptions, inability to obtain
financing

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How do banks manage liquidity risk?

From a bank’s perspective liquidity risk is managed by Liquidity Coverage Ratio (LCR), Net
stable Funding Ratio (NSFR), conducting regular liquidity stress tests, creating contingency
plans.

LCR & NSFR were introduced as part of Basel iii post crisis reforms.

LCR is designed to ensure that banks hold a sufficient reserve of high-quality liquid assets
(HQLA) to allow them to survive a period of significant liquidity stress lasting 30 calendar days.

LCR= Stock of HQLA/ Total Net Cash outflows in 30 days >= 100%

Total NCOs are defined as the total expected cash outflows minus total expected cash inflows
arising in the stress scenario.

What is HQLA?

High Quality Liquid Assets are cash or assets that can be converted into cash quickly through
sales with no significant loss of value.

What is NSFR?

NSFR requires banks to maintain a stable funding profile in relation to the composition of
their assets. A sustainable funding structure is intended to reduce the likelihood that
disruptions to a bank’s regular source of funding will erode its liquidity position in a way that
would increase the risk of its failure.

NSFR= Available amount of stable funding / Required amount of stable funding >= 100%

Funding tenor- NSFR is generally calibrated such that longer term liabilities are assumed to be
more stable than short term liabilities.

FUNDS TRANSFER PRICING (FTP)

Treasuries are mini-banks for their own companies (or banks) and must price up the liabilities
on hand for use in everyday asset-generating activities. The FTP reflects the cost of liabilities
and is charged to a business unit when it wishes to originate a new asset. Unlike the widely-
known cost of debt figure, which can be represented as a standalone loan or benchmark bond
yield, the FTP represents a fully-loaded cost. By that, I mean that it is the overall weighted
average cost of all liabilities plus the internally shared costs of the business minus treasury
profit.

Sources: https://www.treasurefi.com/blog/a-primer-on-treasury-management

Sources: https://www.toptal.com/finance/treasury-manager/treasury-management-best-
practices

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