Cash Management

All Eyes on Treasury

The function that no one likes to think about is now getting plenty of attention, and even a little respect.
Vincent RyanJanuary 1, 2009

Cash-flow traffic cop, investment expert, in-house banker, judge of capital-investment decisions, financial risk manager — treasury departments wear all these hats and more. Yet treasury doesn’t get much respect. It’s often the leanest department in finance, with relatively few resources at its disposal. In 2007, only 14 percent of new CFOs came from treasury, according to one study. There’s little standardization across companies — no common set of metrics or even a commonly accepted description of treasury’s functions. The CEO and management team are typically disconnected from the department, says Brad Buss, CFO of Cypress Semiconductor. “Treasury is like taxes: people don’t really get it and they don’t want to get involved,” he says.

At least, they didn’t. Today, with the economy in a shambles, CFOs are rediscovering the potency of the treasury function.

The need for tight cash management is greater than ever, while the banking crisis has elevated financial-counterparty risk. As a result, expert treasury departments are more highly valued, by finance departments and by boards and business units. “Treasurers have always played a pivotal role in industrial companies,” says Ed Liebert, chairman of the National Association of Corporate Treasurers (NACT) and treasurer at Rohm and Haas. “But with the financial crisis coming to center stage, the role of treasury in protecting a company’s financial assets is becoming more widely recognized.”

As a result, CFOs are revisiting the priorities of the treasury function. Is it focusing on the right tasks among its jumble of responsibilities? And are those tasks delivering value to the company? The consensus is that treasury can play a more strategic role by concentrating on three areas: the care and feeding of banking relationships, the management of working capital, and the screening of capital investments.

Monitoring the Banks

Treasury departments now spend a significant amount of time and energy probing for land mines in the financial markets. “The number-one thing is to protect the assets you do have under your control,” says Dennis Hoyt of Hoyt Treasury Services, an outsourcing provider. That’s essential because CFOs are relying just as much on commercial banks for executing treasury functions (82 percent) and borrowing (72 percent) as they were before the blowup of Lehman Brothers, according to CFO Research. In the past, says Melissa Cameron, a principal in treasury consulting at Deloitte & Touche, treasury departments would have simply stuck the credit-rating reports of their banking partners in a file drawer and forgotten about them; now they continuously scrutinize those institutions using leading indicators such as changes in credit default swap (CDS) spreads and market capitalization.

CFOs, in fact, want daily reporting on their banks’ health. The performance of a bank’s CDSs — “a leading indicator of how the markets perceive financial institutions,” says Cameron — and bond spreads are of particular interest. “CFOs and treasurers are now more likely to devise dashboards that monitor key metrics,” she notes, “because ratings-agency actions are lagging indicators.”

At education-software provider Blackboard, senior vice president of global treasury Michael J. Stanton tracks the financial viability of the two banks that provide the company’s cash-management services. “It’s an issue that’s top of mind at the board and audit-committee level — we have regular conversations about it on audit-committee calls,” he says. Stanton presents the audit committee with data on bank credit ratings, CDS performance, strength of assets, and adequacy of core capital. “Anywhere there is financial risk, we’re diving a lot deeper.”

While Blackboard has not switched banks, Stanton decided not to present a request for proposal for a new “operating bank.” Explains Stanton: “The managing directors we talked to said they would love to have our business but they had unprofitable account relationships that they were trying to clean up. Normally we would have had 20 banks pitching.” In the end, Blackboard stayed put, deciding there was greater risk in moving its accounts.

Ultimately, treasurers want what consumers want: an ironclad guarantee for their cash accounts, says Scott Horan, a senior vice president in liquidity management at PNC Bank. “Businesses are looking for some kind of government guarantee for their short-term cash — they want safety and liquidity but no one considers yield as a criterion,” he says. Enter the Federal Deposit Insurance Corp. In addition to the U.S. Treasury Department backing money-market funds, the FDIC is guaranteeing non-interest-bearing transaction accounts at U.S. banks through 2009. Given that guarantee, the earnings credits that companies can apply toward bank fees, and the low yield on Treasuries, Horan says that for some companies it makes sense to park cash in a checking account.

Monitoring banks has value to corporations beyond just guarding cash. Zurich Financial Services, for example, relies on bank letters of credit and trusts to mitigate customer and other third-party credit risk. “Treasury has to actively manage that in light of some of the weekly changes in the health of some banks,” says Vibhu Sharma, CFO of the North American commercial business of Zurich Financial. “We have to have the ability to change out the collateral if a bank heads toward insolvency.” Thus far Zurich has avoided what Sharma calls “double jeopardy” — when a customer and the bank that posts its collateral go into simultaneous tailspins.

Numbers don’t tell CFOs and treasurers the whole story about a bank, though. That’s why Cypress Semiconductor holds monthly calls with its banks and money managers, a practice its financial-services partners willingly submit to. “I like to hear their voices. In these times you need to talk to people,” says CFO Buss.

Top-flight treasury departments do more than simply communicate with their banks — they also leverage the relationship. Some companies are choosing to help shore up the balance sheets of upstream partners, for example, by aiding them in obtaining credit, says the NACT’s Liebert. In such instances, the supplier transfers the customer’s receivables to a bank, which then provides lower-cost financing to the supplier based on the customer’s credit rating. “That can help the business and banking relationship while improving the working-capital management of the higher-grade company,” explains Liebert.

Prospecting for Cash

The management of working capital is an area in which many treasury departments can be more active. Uncovering extra cash in this economy is like finding gold. World Fuel Services, a $13 billion seller of marine, aviation, and ground-based fuels, has spent several months reeducating its global team on working capital’s impact on cash flow and overall return, says CFO Ira Birns. “It makes even more sense as record-breaking crude-oil prices earlier in the year resulted in an increase in our net working-capital investment,” he says. The company set internal targets for working-capital performance by business segment and is including such targets in its incentive compensation schemes. The heightened discipline paid off in increased margins and a decrease in the company’s net trade cycle in the third quarter, he says.

At specialty chemicals maker Ashland, the $3 billion purchase of Hercules in November 2008 turned the firm from a net investor with $1 billion on the books to a net debtor ($2.6 billion debt, $200 million cash). “It’s a huge change for us,” says J. Kevin Willis, the company’s treasurer. In addition, the installation of an enterprise resource planning system caused working capital to rise a couple of percentage points.

The ERP system payback, however, including demand forecasting and inventory control, supported a comprehensive strategy to generate cash and pay debt. Together with an initiative tying 40 percent of variable pay to working-capital levels, it resulted in reducing working capital by 3 percent of sales ($260 million) last year. “We’re managing a debt load, so we have to ensure our business performs optimally,” Willis says.

“Working capital represents a tremendous opportunity for treasury,” says Peter Pinfield, a partner at Treasury Alliance Group, because business units and treasury are often working at cross-purposes. “When capital was plentiful, production people never wanted to run out of stuff, and buyers wanted to order in large quantities to get economies of scale,” Pinfield says. What’s more, overseas sourcing, with its longer lead times, increased many industries’ inventory levels.

Still, businesses lowered inventories by $29.1 billion (2 percent) last September, after reducing them $50.6 billion in the previous quarter. Inventory-to-sales ratios for manufacturers, retailers, and merchant wholesalers have been dropping steadily since 1992, when the Census Bureau started collecting such data.

If the announcements of some very large organizations are to be believed, there is still fat to be cut. Last quarter, Bristol-Myers Squibb CFO Jean Marc Huet announced a working-capital initiative to free up $750 million to $1 billion cumulatively through 2011. It will do so through better management of payables, receivables, and inventory. The $19 billion company is negotiating terms with vendors and partners, for example, and going through product and plant rationalizations to reduce inventory. “If you have a product with seven different dosages, and 90 percent of the demand is for two of those, why do you need the others?” asks Brian Henry, a spokesman for the company.

Other large drugmakers are tying up cash with sloppy inventory practices, according to a report by Ernst & Young. Because of the industry’s high operating margins and strong balance sheets, “a cash culture never developed,” says the report. “Inventory levels were not kept low, because companies did not want to run the risk of disrupting patients’ lives and missing a profitable sale.” Combined, 16 of the largest drugmakers could free up $17 billion to $35 billion in cash from working capital through better inventory management, E&Y estimates.

“Agonizing” Decisions

Across the board, companies have slammed the brakes on capital spending to minimize the outflow of cash. Capex increased 18 percent in 2006 but just 3 percent in 2007 among a sample of 300 companies, according to management consulting firm PRTM. But a smart treasury department, which determines the present value of a project and how it will be financed, has to raise the bar even higher for capital investment during a recession. “CFOs and treasurers are postponing projects with a long time frame or stopping projects that have a low payback,” says Dennis Hoyt. “They are also revisiting assumptions like interest rates and sales to be generated.” Echoes the NACT’s Liebert: “You really have to take into consideration the delay in cash flow that might occur because of the global economic slowdown. You have to look at those return calculations.”

The closed-off credit markets are making the assessment of strategic investments “agonizing,” says one West Coast treasurer whose company relies on access to securitized debt. The company’s biggest worry is that a request for a credit-line drawdown won’t be honored or the bank will demand a new rate based on its cost of funds instead of LIBOR. “When there was an abundance of credit we took advantage of opportunities as quickly as we could,” says the treasurer. “Now we don’t know if the credit markets will respond to our needs. It affects the company’s entire strategic direction.”

Even companies awash in credit and cash concerns are slicing project outlays — and letting business units know about the cuts upfront. At Cypress Semiconductor, projects have to go through a capital review board consisting of the CFO, the financial-planning and -analysis manager, the controller, the treasurer, and four executive vice presidents. The board meets every two months to examine new proposals. By communicating capital cuts upfront for 2009, Buss says he avoided having people “waste time with the song and dance in front of the review board.”

Once the board OKs an expenditure, investments over $100,000 are subjected to a return-on-capital business case. The board even reviews projects that have already been greenlighted, in effect zeroing out the budget every 90 days. “It gets people to rejustify what they need,” Buss says.

Zurich Financial is also being more diligent in the capital-project screening process for 2009. Determining the correct time horizon is crucial in the cost-benefit analysis, CFO Sharma says, as is assessing the strategic value and necessity of a project. “We’re looking for ‘must-haves’ that are strategic, versus a ‘nice-to-have’ that’s strategic,” he says. “The nice-to-haves might not get funded.”

Many companies are scotching capital-expansion programs altogether. Since such programs can be the largest users of cash, a slowdown amounts to a “cash management” strategy. The dangers of being too conservative: forgoing projects that could generate cash flow, operating earnings, and potential cost savings. Also, in this environment, organic growth may offer the only hope of a boost to a company’s share price. Many companies have slashed buybacks and dividends, although the conversations about them continue. Blackboard’s stock was off 50 percent year-to-date last November and its bonds traded in the low 70s. “Investors are asking us why we aren’t buying back stock at these levels,” says Stanton. “You can make a good argument for that, but you’d be giving up financial flexibility at a time when the term-loan market doesn’t exist.”

The Nature of the Job

Treasury covers a lot of ground, and that can trip up even the most solid operation. It’s hard to be good at everything. CFOs “want to be completely comfortable with the whereabouts of every dollar or dollar equivalent on [their] balance sheet on any given day,” says World Fuel’s Birns. But at the same time, they want treasurers to keep their heads up and closely track the safety of cash investments and the soundness of counterparties.

Plagued by increasing demands for information, data, and analysis — and rarely given additional resources to meet these requests — many treasury departments risk missing the next turn in the financial markets. To do so, even by a hair, can be costly. That’s the true calling of a treasury department, says Buss. Getting ahead of the curve — forecasting, for example, the timing of when credit markets will loosen and when it will be wise to free up more capital for investment — is a key part of treasury’s risk-management role. Even if treasury does manage to succeed at that delicate task, it may not alter its status within the corporation. Says Craig Jeffery, managing director of Strategic Treasurer: “Treasury is in a position where you can only get into trouble. If you do well, people expect it.”

Maybe so, but if treasury can help a company navigate through such unprecedentedly perilous times, it may get what is currently a rare commodity: credit.

Vincent Ryan is a senior editor of CFO.