treasury management in corporates

TREASURY MANAGEMENT IN CORPORATES

05/01/2023

TREASURY MANAGEMENT

Treasury Management (or treasury operations) includes management of an

enterprise's holdings, with the ultimate goal of maximizing the firm's liquidity and

mitigating its operational, financial and reputational risk

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IN CORPORATES

To maintain the liquidity of business

Develops and executes all capital market activity

Manages the financial risks of the company

Implementing company’s optimal capital structure

To provide quick finance to Company

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TREASURY MANAGEMENT

Working Capital

Management

Cash Management

Financial Risk

Management

Capital Markets and

Funding

Corporate Financial

Management

Treasury Management

CASH MANAGEMENT

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SIGNIFICANCE OF CASH MANAGEMENT

• Cash – “Life blood of a business”

Motives of holding cash

Transactions Motive

Precautionary Motive

Speculative Motive

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CASH PLANNING

Cash Planning is a technique to plan and control the use of cash

Cash Forecasting and Budgeting Cash budget is the most significant device to plan for and control cash

receipts and payments Cash forecasts are needed to prepare cash budgets

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TYPES OF CASH FORECASTING

SHORT TERM LONG TERM

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METHODS OF CASH BUDGETING• Receipts and Payments MethodShows timing and magnitude of expected cash receipts and payments over forecast period

Advantages: It gives a complete picture of all the items of expected cash flows.

Limitations: Its reliability is reduced because of the uncertainty of cash forecasts It fails to highlight the significant movements in the working capital

items

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Month Month Month Balance b/d ( 1 )

Receipts Cash SalesCredit SalesBank Loans Other Receipts Total Receipts ( 2 )

Payments Cash and Credit PurchasesGeneral and Admin ExpensesTax payments Interest payments DividendsInvestment in short term securities Total Payments ( 3 ) Net Cash Flow ( 2 - 3 )

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ADJUSTED NET INCOME METHOD

• Adjusted Net Income Method

This method involves tracing of working capital flows

It is also called as the Sources & Uses approach

It generally has 3 sections: Sources, Uses & Adjusted cash balance

Objectives:

To project company’s need for cash at a future date

To show whether company can generate funds internally

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Year Year Year Cash beginning of year

Sources of Cash Net Income Non cash charges Increase in Borrowing Sale of equity shares Miscellaneous Total ( 1 )

Uses of Cash Capital Expenditures Increase in Current Asset

Repayment of borrowings Dividends Payments Total ( 2 )

Surplus/ Deficit ( 1 – 2 )

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Advantages:

It highlights the movements in the working capital items, and thus helps to keep a control on a firm’s working capital

Limitations:

It fails to trace cash flows, and therefore, its utility in controlling daily cash operations is limited

CASH COLLECTIONS AND DISBURSEMENTS

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FLOAT

Float : Difference between the available balance and book balance of company

Float Time is the time between a customer initiating a payment and the company being informed that it has obtained value at the bank

Types of Float: Payment or Disbursement Float Availability or Collection Float Net Float

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• Cheques issued by a firm creates Disbursement Float

Eg : Bharat Company

• On 1st April it pays 1 million by cheque to one of its suppliers

• Disbursement Float = Firm’s available balance – Firm’s book balance = Rs 1 million

On 31st March

Book Balance Rs. 4 million

Bank Balance Rs. 4 million

On 1st April



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• Cheques received by a firm creates Collection Float

Eg : Bharat Company

• On 1st May it receives a cheque for 1.5 million from customer

• Collection Float = Firm’s available balance – Firm’s book balance = Rs -1.5 million

On 30th April



On 1st May

Book Balance Rs. 6.5 million


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• Net Float = Disbursement Float + Collection Float

Disbursement float > Collection float.

Positive Float, Available balance > Book Balance

Disbursement float < Collection float

Negative Float, Available balance < Book Balance

If the company has a positive net float, it may issue more cheque amounts, even though the balance as per its book is lower.

So, a company that has a positive net float at a point of time can effectively use and manage the float in such a way that it can maintain a smaller cash balance.

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SPEED UP COLLECTIONS

• Collection Time

Customer mails the cheque

Company receives the cheque

Company deposits the cheque

Cash available

Mailing Time

Processing Availability delay

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Concentration banking

Company asks its customer in a particular area to send payments to a local branch office rather than to the corporate HQ

Clients pay in Local branch office instead

Company’s HQ

Deposit cheque into Local bank

A/c

Surplus Funds are transferred to

Concentration A/c

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Lock boxes

Customers are advised to mail their payments to special post office boxes called lockboxes, which are attended to by local collecting banks, instead of sending them to corporate headquarters

• Cuts down the mailing time

• Reduce the processing time

• Shortens availability of delay

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Corporate Customer

Corporate Customer

Corporate Customer

Corporate Customer

Local banks collect funds

Separation of cheques and

receipts

Cheque deposited in

banks

Bank clears cheques

Post office box 1 Post office box 2

Details of receivable go to

firm

Firm processes receivables

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Avg. number of daily payments to Lock Box 150

Avg. size of payments Rs. 1200

Rate of Interest per day 0.02 %

Saving in Mailing time 1.2 days

Saving in Processing time 0.8 day

Thus, the Lock Box would increase the collected balance by:150 (payments per day) * Rs. 1200 (Avg. Payment) * (1.2 + 0.8) days saved = Rs.360,000

Invested at 0.02% per day, gives a daily return of: 0.0002 * Rs. 360,000 = Rs. 72

If bank charges 0.26 per check , i.e. 0.26 * 150 = Rs. 39 per dayNet gain is Rs.72 – Rs. 39 = Rs. 33

Favorable to have Lock Box

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Electronic Fund Transfer

• Online based transaction from one bank account to another

• Reduces the time taken to carry out a transaction

• RTGS and NEFT

• Wire transfer for International transactions (SWIFT)

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OPTIMUM CASH BALANCE

Enough in order to make payments when needed Additional cash for unexpected requirements

Two Models for Optimum Cash Balance

Under certainty –

Baumol’s model

Under uncertainty -

Miller-Orr model

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BAUMOL’S MODEL

William J. Baumol developed a model (The transactions Demand for Cash : An Inventory Theoretic Approach) which is usually used in Inventory management & cash management.

It Trade off between opportunity cost or carrying cost or holding cost & Transaction cost

As such firm attempts to minimize the sum of the holding cash & the cost of converting marketable securities to cash

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The firm is able to forecast its cash needs with certainty

The firm’s cash payments occur uniformly over a period of time

The opportunity cost of holding cash is known and it does not change over time

The firm will incur the same transaction cost whenever it converts securities to cash

Baumol’s Model–Assumptions

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F = The fixed cost of selling securities to raise cash

T = The total amount of new cash needed

K = The opportunity cost of holding cash: this is the interest rate.

If we start with $C, spend at a constant rate each period and replace our cash with $C when we run out of cash, our average cash balance will be

2C

The opportunity cost of holding is

2C KC

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F = The fixed cost of selling securities to raise cash

T = The total amount of new cash needed

K = The opportunity cost of holding cash: this is the interest rate.

As we transfer $C each period we incur a trading cost of F each period. If we need T in total over the planning period we will pay $F, T ÷ C times.

The trading cost is FCT

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C* Size of cash balance

FTKC

C2cost Total

Opportunity Costs

KC

2

FT

CTrading

costs

The optimal cash balance is found where the opportunity costs equal the trading costs

FKTC

2*

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Limitations :

The model assumes the firm has a constant disbursement rate

The model assumes there are no cash receipts during the projected period

Treasurers may want a ‘safety stock’ for cash

THE MILLER-ORR MODEL

The firm allows its cash balance to wander randomly between upper and lower control limits.

The models answers the following questions: When should transfers be effected between marketable securities and cash? What should be the magnitude of these transfers?

Assumptions: There is no underlying trend in cash balance over time The optimal values of LL and RP depend not only on the fixed and opportunity

costs but also on the degree of likely fluctuations in cash balances

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LL – Set By Management

RP + LL

UL = 3RP – 2LL

CASH MANAGEMENT TOOLS

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NETTING

A process where instead of settling each separate transaction, the company creates a netting center

This acts like a clearing house that adds & subtracts the various amount of inter subsidiary payables & receivables

At the end of month, each subsidiary pays or collects one net payment from the netting center.

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BILATERAL NETTING: AN EXAMPLEConsider a U.S. MNC with three divisions and the

following foreign exchange transactions:

$10 $35 $40$30

$20

$25 $60

$40$10

$30

$20$30

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BILATERAL NETTING: AN EXAMPLEBilateral Netting would reduce the number of foreign exchange

transactions as follows; Examine U.S and Canadian affiliate

$10 $35 $40$30

$20

$25 $60

$40$10

$30

$20$30

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BILATERAL NETTING: AN EXAMPLEBilateral Netting: U.S. and Canada net out at $10

$10 $35 $40$30$25

$60

$40$10

$10

$20$30

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BILATERAL NETTING: AN EXAMPLEBilateral Netting: Canadian and U.K. affiliates.

$10 $35 $40$30$25

$60

$40$10

$10

$20$30

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BILATERAL NETTING: AN EXAMPLEBilateral Netting: Canadian and U.K. affiliates net out

at $10

$10 $35 $10$25

$60

$40$10

$10

$20$30

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BILATERAL NETTING: AN EXAMPLEBilateral Netting: U.K. and German affiliates.

$10 $35 $10$25

$60

$40$10

$10

$20$30

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BILATERAL NETTING: AN EXAMPLEBilateral Netting: U.K. and German affiliates net out

at $10

$10 $35 $10$25

$60

$40$10

$10

$10

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BILATERAL NETTING: AN EXAMPLEBilateral Netting: U.S. and German affiliate.

$10 $35 $10$25

$60

$40$10

$10

$10

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BILATERAL NETTING: AN EXAMPLEBilateral Netting: U.S. and German affiliate net out at

$25.

$25 $10$25

$60

$40$10

$10

$10

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BILATERAL NETTING: AN EXAMPLEBilateral Netting: U.S. and U.K. affiliate.

$25 $10$25

$60

$40$10

$10

$10

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BILATERAL NETTING: AN EXAMPLEBilateral Netting: U.S. and U.K. affiliate net out at $20.

$25 $10$25

$20 $10

$10

$10

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BILATERAL NETTING: AN EXAMPLEBilateral Netting: German and Canadian affiliates.

$25 $10$25

$20 $10

$10

$10

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BILATERAL NETTING: AN EXAMPLEBilateral Netting: German and Canadian affiliates net

out at $15

$25 $10$15 $20

$10

$10

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BILATERAL NETTING

Before bilateral netting: Total funds (gross) to be moved: $350

With bilateral netting: Total funds (net) to be moved: $90

This is a reduction of $260 in foreign exchange transactions.

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MULTILATERAL NETTING: AN EXAMPLEConsider simplifying the bilateral netting with

multilateral netting: Start with the bilateral amounts.

$25 $10$15 $20

$10

$10

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MULTILATERAL NETTING: AN EXAMPLEU.K. affiliate owes the German affiliate $10; the

German affiliate owes U.S. $10.

$15 $10$15 $20

$10

$10

$10

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MULTILATERAL NETTING: AN EXAMPLEThus, the U.K. affiliate nets its payment to the U.S. of

$10.

$15 $10$15 $20

$10

$10

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MULTILATERAL NETTING: AN EXAMPLEU.K. net payment of $10 to U.S. is combined with the

$20 it owes.

$15 $10$15 $20

$10

$10

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MULTILATERAL NETTING: AN EXAMPLEU.K. affiliates owes $30 to U.S.

$15 $10$15 $30

$10

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MULTILATERAL NETTING: AN EXAMPLEConsider Canadian and German affiliates.

$15 $10$15 $30

$10

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MULTILATERAL NETTING: AN EXAMPLECanadian affiliate owes German affiliate $15 and the

German affiliate owes the U.S. $15.

$15 $10$15 $30

$10

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MULTILATERAL NETTING: AN EXAMPLECanadian affiliate nets its payment to the U.S. of $15;

total Canadian affiliate payment to U.S. $25.

$10

$15

$30

$10

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MULTILATERAL NETTING: AN EXAMPLEConsider Canadian and U.K. affiliate

$10

$15

$30

$10

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MULTILATERAL NETTING: AN EXAMPLEU.K. affiliate owes Canadian affiliate $10; Canadian

affiliate owes U.S. $10.

$10

$15

$30

$10

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MULTILATERAL NETTING: AN EXAMPLEU.K. affiliate nets its payment to the U.S. of $10.

$10

$15

$30

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MULTILATERAL NETTING: AN EXAMPLECombine this $10 with the $30 the U.K. affiliate owes

the U.S.

$10

$15

$30

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MULTILATERAL NETTING: AN EXAMPLEU.K. affiliate owes the U.S. $40.

$15

$40

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MULTILATERAL NETTING: AN EXAMPLETotal funds to be moved under multilateral netting is

$55.

$15

$40

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SUMMARY OF NETTINGCompare this (before netting).

$10 $35 $40$30

$20

$25 $60

$40$10

$30

$20$30

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BILATERAL NETTINGTo this.

Bilateral Netting: Total funds moved = $90

$25 $10$15 $20

$10

$10

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Decrease in the expenses associated with moving funds internationally Decrease in the number of foreign exchange transactions (also reduces costs) Reduction in intra-company float (wire transfers can take up to 5 days)

Financial rewards Favorable foreign exchange rates due to consolidation of several smaller payments to one

large payment

Reduces administration cost

Control advantages Forces tighter control over information on transaction between subsidiaries

Reduces time spent on administration & simplifies the reconciliation process

Benefits of Netting

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Cash in excess of operating requirement may be held for two reasons To meet fluctuations in working capital

As a buffer to meet unpredictable financial needs

Selecting Investment Opportunity Safety

Maturity

Marketability

Investing Surplus cash

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INVESTING OF SURPLUS CASHInstruments Safety Maturity

Treasury Bills Safe 91 days & 364 days

Commercial Papers RiskyMin 7 days & Max 1

year from date of issue

Certificates of Deposits

Safe 7 days to 1 year

Bank Deposits Safe Min 14 days

Inter-corporate deposits

Risky Min 1 day, Max 1 year

Money market mutual funds

Risky 15 days

CORPORATE FINANCIAL MANAGEMENT

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CAPITAL DECISIONS

Financing

How much?

From where/whom?

What cost?

When to mobilize?

WORKING CAPITAL MANAGEMENT

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WORKING CAPITAL MANAGEMENT• Working capital management is the management of the short-term investment and financing of

a company.

• Working capital management is to do with management of all aspects of both current assets and current liabilities, so as to minimize the risk of insolvency while maximizing return on assets

GOALS:

• Adequate cash flow for operations

• Most productive use of resources

• Satisfy maturing short term debt

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DETERMINANTS OF WORKING CAPITAL• Nature of the business

• Sales and demand conditions

• Manufacturing policy

• Credit policy

• Availability of credit

• Operating efficiency

• Price level changes

• Growth and expansion plan

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CLASSIFICATION OF WORKING CAPITAL

• There are two possible interpretations of working capital concept

KINDS OF WORKING CAPITAL

ON THE BASIS OF TIMEOPERATING CYCLE CONCEPT

ON THE BASIS OF CONCEPTBALANCE SHEET CONCEPT

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BALANCE SHEET CONCEPT

• There are two interpretations of working capital under the balance sheet concept

BALANCE SHEET CONCEPT

GROSS WORKING CAPITAL

NET WORKING CAPITAL

GROSS WORKING CAPITAL = TOTAL CURRENT ASSETS

NET WORKING CAPITAL = CURRENT ASSETS – CURRENT LIABILITIES

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WORKING CAPITAL CYCLE

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ON THE BASIS OF TIME

OPERATING CYCLE CONCEPT

REGULAR WORKING CAPITAL

PERMANENT OR FIXED WORKING

CAPITAL

TEMPORARY OR VARIABLE WORKING

CAPITAL

SPECIAL WORKING CAPITAL

SEASONAL WORKING CAPITAL

RESERVE WORKING CAPITAL

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PERMANENT WORKING CAPITAL

It is the minimum level of current assets that the firm maintains

Permanent Working Capital can be further divided into:

Regular working capital:

It is the minimum amount of liquid capital required to keep up the circulation of the capital from cash to inventories to receivables and back again to cash.

Reserve margin or cushion working capital:

It is extra capital required to meet unforeseen contingencies that may arise in future.

ON THE BASIS OF TIME

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TEMPORARY OR VARIABLE WORKING CAPITALIt is the extra working capital required to support the changing production and sales activities of the firm

Variable Working Capital can be further divided into:

Seasonal working capital:

It refers to liquid capital needed during the particular season.

Special working capital:

It is that part of the variable capital which is needed for financing special operations

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DIFFERENCE BETWEEN PERMANENT & TEMPORARY WORKING CAPITAL

Amount Variable Working Capitalof WorkingCapital

Permanent Working Capital

Time

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Variable Working CapitalAmount of WorkingCapital

Permanent Working Capital

Time

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DANGERS OF INSUFFICIENT WORKING CAPITAL

Full utilization of fixed assets is not possible

Difficulty in the Maintenance of Machinery

Decrease in Credit Rating

Non utilization of favourable opportunities

Decrease in Sales

Difficulty in distribution of dividends

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DANGERS OF EXCESSIVE WORKING CAPITAL

Excessive Inventory

Excessive Debtors (liberal Credit policy)

Adverse effect on profitability

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FINANCING WORKING CAPITAL

Long Term Financing

Short Term Financing

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APPROACHES TO DETERMINE AN APPROPRIATE FINANCING-MIX

The Matching approach

Conservative approach

Aggressive approach

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FINANCING NEEDS OVER TIME

Fixed Assets

Permanent Current Assets

Total Assets

Fluctuating Current Assets

Time

$

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MATCHING APPROACH TO ASSET FINANCING

Fixed Assets


Total Assets


Time

$

Short-termDebt

Long-termDebt +EquityCapital

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CONSERVATIVE APPROACH TO ASSET FINANCING

Fixed Assets


Total Assets


Time

$

Short-termDebt

Long-termDebt +Equity capital

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AGGRESSIVE APPROACH TO ASSET FINANCING

Fixed Assets


Total Assets


Time

$

Short-termDebt

Long-termDebt +Equity capital

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RELATIVE PROPORTION OF LONG TERM AND SHORT TERM DEBT

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COMPARING THE THREE STRATEGIES OF WORKING CAPITAL FINANCING

FACTORS CONSERVATIVE AGRESSIVE MATCHING

LIQUIDITY HIGH LOW BALANCED

PROFITABILITY LOW HIGH BALANCED

RISK LOW HIGH BALANCED

ASSET UTILIZATION LOW HIGH MODERATE

WORKING CAPITAL HIGH LOW MODERATE

RISK MANAGEMENT

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WHAT IS RISK?

Risk is the potential that a chosen action or activity (including the choice of inaction) will lead to a loss (an undesirable outcome)

Damodaran says, risk includes not only "downside risk” but also "upside risk" (returns that exceed expectations)

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CORPORATE RISKS

• Business Risks-

Sales

Marketing

Manufacturing

Competition

Reputation

• Market Risks

Foreign Exchange

Interest Rates

Commodity

Equity

Inflation

Liquidity Risks

Funding Risks

Long Term v/s Short Term

Capital

Credit Risks

Commercial

Counterparty

Settlement

Operational Risks

Systems

Controls

Regulatory

Frauds

Weather

Natural disasters

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Definition

It is the identification, assessment, and prioritization of risk followed by coordinated and economical application of resources to minimize, monitor, and control the probability and/or impact of unfortunate events or to maximize the realization of opportunities.

Risk Management

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How To Manage Risk?

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Risk Management TechniquesAvoidance

Loss Prevention

Loss Reduction

Seperation

Diversification

Risk Control

Transfer

Insurance

Hedging

Retention

Risk Financin

g

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HEDGING

Hedging is the act of reducing your risk of losing money in the future.

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BENEFITS OF HEDGING

Hedging as a strategic resource

Capital raising capability

Lowering distress costs

Lowering tax liabilities

Hedging as a tool for corporate governance

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HEDGING STRATEGIES/ INSTRUMENTS

Forwards

Futures

Options

Swaps

FOREX HEDGING

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FOREIGN EXCHANGE EXPOSURE RISK

Transaction

Translation

Economic

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TRANSACTION EXPOSURE

∆ in FE rate ∆ in outstanding obligations

Hits the P&L a/c, profitability takes a hit

Initiate the deal

Negotiation Modifying or accepting the deal

Final delivery date

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The Net Positive Transaction Exposure indicates strengthening of the domestic currency against the foreign currency and depreciation of the foreign currency makes it profitable.

The Net Negative Transaction Exposure indicates strengthening of domestic currency against the foreign currency and appreciating of the foreign currency makes it profitable.

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STRATEGIES FOR TRANSACTION EXPOSURE

Hedging

Currency invoicing

Exposure netting

Leading & lagging

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EXAMPLE ON HEDGING

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ON HEDGING

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LEADING & LAGGING

Indian Manufacture has today $1million for import material and to receive $1million from export order

1USD = 60 INR

Expecting rupee to appreciate (eg 59)

Expecting rupee to depreciate(eg 61)

Payments – delay the payment (lagging) Payments- prompt payments (leading)

Receipts-immediate receipt (leading) Reciepts- delay the receipt (lagging)

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EXPOSURE NETTING

XYZ CO.(CANADA)

US SUPPLIER

A CO.(Europe)

B CO.

Pay $10million

Receive Euro 5million

Receive 1millionCHF

The company’s net currency exposure is USD 2.15 million (i.e. USD 10 million – [(5 x 1.35) + (1 x 1.10)]

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TRANSLATION EXPOSURE

Four Methods to translate foreign currency to home currency:

Current/Non-Current Method: All current assets and current liabilities are translated at current exchange rate

Monetary/ Non-Monetary Method: All monetary assets and liabilities are translated at current exchange rate

Temporal Method: Same as Monetary/Non-Monetary method BUT inventory may be translated at current exchange rate IF it is shown at market value

Current Rate Method: All balance sheet and income statement items are translated at current exchange rate

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TATA UK (Parent company) has a subsidiary in US

Tata invests $5,00,000 in its subsidiary in US (USD/EUR=1)

On the year end closing date the $ (USD/EUR=2)

Instead of 5,00,000 euros only 2,50,000 euros are translated (5,00,000/2)

EXAMPLE

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ECONOMIC EXPOSURE

Unexpected currency fluctuations on a company’s future cash flows and market value

Long term in nature

Substantial Impact

Difficult to quantify

INTEREST RATE HEDGING

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Cash Flow of A = - Fixed – Float + Fixed

Cash Flow of B = - Float – Fixed + Float

Bank

B A

Bank

Fixed

Float

Float

Fixed

COMMODITY HEDGING

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CASE STUDY

• Oil refinery XYZ ltd needs 1,00,000 barrels of crude oil in 3 months.

• Current market price is $44.20/barrel

• Crude oil futures $44.00/barrel

100 contracts of 1000 each: 100 x 1000

=1,00,000 barrels

Total cost =$44,00,000

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SCENARIO #1: CRUDE OIL SPOT PRICE ROSE BY 10% TO USD 48.62/BARREL ON DELIVERY DATE

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SCENARIO #2: CRUDE OIL SPOT PRICE FELL BY 10% TO USD 39.78/BARREL ON DELIVERY DATE

THANK YOU

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treasury management in corporates

Economy & Finance