Balancing strategic and operational needs:

Solving the treasurers dilemma

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Cash Management

A new era
Echoes of the credit crisis are still being felt: as a result of the current political and economic instability, the impact of the global downturn and the threat of a potential reoccurrence, crisis is never far from the treasurers mind. Although 2010 saw moves away from the step-changes in behaviour post-crisis, such as the flight to quality for investments, Francyn Stuckey, Head of Strategic Solution Delivery, Global Treasury Solutions at Bank of America Merrill Lynch, believes that as we move into 2012 the pendulum is swinging back, with a renewed focus on achieving the right balance in every area of treasury from bank relationships to investment objectives. Treasurers therefore have some interesting challenges to address as they attempt to find the right balance between a set of opposing priorities: Security vs yield. Of course treasurers are looking to preserve company cash; however, increasingly they are seeking to make that cash work and return some yield. Risk vs efficiency. Becoming too efficient can come at a cost of increased risk. Standardisation is efficient but a one-pronged tactic can be risky. How can a treasurer find the right balance between risk management and risky practices? DSO vs DPO. Could greater efficiencies be found by concentrating on days sales outstanding (DSO) rather than just on legacy days payables outstanding (DPO) metrics?

Francyn Stuckey
Head of Strategic Solution Delivery Global Treasury Solutions Bank of America Merrill Lynch

As we move through 2011 and prepare for 2012, a number of key themes dominate the transaction banking landscape, each one overlapping and influencing the other, creating a dichotomy in the market:

Internal before external

The continued uncertainty creates some interesting imperatives for treasurers, such as focusing on efficiencies within their business to generate liquidity and harnessing every last cent within the organisation before going to the external market. Therefore working capital efficiency, whilst a very well covered topic, remains a key area of focus. Treasury departments are also focusing their attention on their core business and core competencies. As a result, treasurers are increasingly looking to trusted external partners for managing services that are deemed non-core to the treasury function. This makes external partnerships even more important than in the past not only in terms of reliability, and counterparty risk mitigation, but also for futureproofing the companys treasury function. In this regard, sustainability of the supply chain is a key area of focus.

Relationship and interoperability

The desire to standardise is uppermost for corporates mainly to drive efficiencies but also in the treasury space to provide a degree of flexibility or bank interoperability. Whether the catalyst or the result, the emergence of new technology standards such as ISO 20022 XML, SWIFT, eBAM and SEPA help meet these corporate needs. However while bank interoperability is desired, is it really desirable? Is the best contingency plan one that doesnt have to be used? The focus on interoperability is coupled with more attention to the strength and quality of the bank relationship to best understand who best to partner with. Corporates continue to look for banking providers with experience and expertise, but today we see an increased desire for access to solutions that offer robust risk, financial and liquidity controls too. They want a much more integrated discussion and advice on strategic as well as transactional matters. We see this as a return to old school banking with a real focus on the core relationship fundamentals.

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Banks therefore need to understand their corporate clients priorities and timelines; they need to listen and be proactive, tapping into the full wealth of experience of their organisation by function, geography and market. Corporates are also looking to their banks to identify opportunities to introduce and share best practices thereby providing a truly integrated, collaborative and multilevel relationship from the CFO to the operations teams.

Treasury in the trenches

Today the treasury function has a much broader set of responsibilities including enterprise risk management, technology and systems, working capital and liquidity management, insurance, pensions and cash flow forecasting to name but a few and much has already been written on this topic. But not only has the treasurers role expanded, it has also deepened. This has caused a so-called T-bar effect where the treasurer not only has a growing strategic role, but he or she also has a more extensive operational role.

Not only has the treasurers role expanded, it has also deepened. This has caused a so-called T-bar effect where the treasurer not only has a growing strategic role, but a more extensive operational role.

Over time, the need for strategic banking relationships has naturally led to diversification of banking providers. It is true this goes some way to managing the risk associated with having all your eggs in one basket but at the other end of the spectrum, overdiversification can also pose a risk. For example, does the optimal diversification of bank provider mean two banks or 50? Over-diversification also impacts efficiency, so in essence the argument comes full circle. In the new era, it is a question of addressing the balance between internal resources (and competencies) and those available externally, between relationship and interoperability, and between the strategic and the operational.

Collaborative change
The past couple of years have seen some fundamental shifts in the way services are delivered and how banks are positioning themselves to respond to the growing needs of their corporate clients. Forward-thinking institutions have become far more open to a collaborative banking approach to extend their existing footprint and capabilities, realising that they cannot serve clients needs in every single jurisdiction on their own: they need strategic partners. For example, Bank of America Merrill Lynchs truly integrated partner bank model across the EMEA region fully satisfies the many clients it serves. This model is entirely transparent to the client and offers extended footprint and capabilities using an enhancing bricks with clicks approach. Elsewhere, regulatory changes such as Basel III, industry initiatives like SEPA in Europe, as well as developments in technology, XML for example, are driving new ways of providing best-in-class solutions, with outsourcing once again coming onto the radar. However some of the changes have not yet realised their full potential. SEPA is a case in point as neither banks nor corporates are done in this area yet. The benefits of migrating to SEPA could be seen as a risk mitigation tool rather than a pure cost saving vehicle, for example. Many of the corporates with a cost agenda have already moved realising FTE benefits. The SEPA business case is much more about the removal of formatting, legacy coding and soon to be obsolete payment types. However despite its risk mitigation benefits, SEPA still needs to be considered as part of an overall re-engineering of treasury processes. Banks really do need to do more to help their clients make the changes required to embrace SEPA. Treasury practitioners are also being required to do much more with less, so whilst risk and liquidity management may have increased priority, other tasks, though still vital, have been unintentionally relegated. This is why it is so important that banks work alongside their clients to really get to know the challenges corporates face in their business such as funding, forecasting and cash application and then to develop solutions that help address them.

Corporates want easy access, holistic systems integration and the ability to future-proof their business.

Corporates want easy access, holistic systems integration and the ability to future-proof their business. Instead of technology for technologys sake, they want to achieve the true benefits that can be realised through a collaborative approach and the right solutions. Its about investing for efficiencies and success now, and in the future. The following sections of this Supplement focus on two key areas within the treasury space where corporates and banks can collaborate more closely. First, we explore the straight through reconciliation landscape and then we look into the area of liquidity management.

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Enhancing STR: a collaborative effort between banks and corporates
Since the start of the credit crisis, banks have been working with their clients to help enhance, optimise and track operational excellence and working capital efficiency. Corporate treasurers are continuously being challenged to come up with ways to work more efficiently, and to automate and optimise their treasury and shared services centre (SSC) processes. Looking at the benefits and gains realised by having company cash in the right place at the right time is a key requirement says Joo Kim Ong Bullock, Head of EMEA Client Information and Integration Services, Global Treasury Solutions, at Bank of America Merrill Lynch.

Joo Kim Ong Bullock

EMEA Head Client Information and Integration Services, Global Treasury Services

In seeking to drive increased working capital efficiency, it is the accounts receivables (A/R) area which is still causing treasurers the biggest headaches. But many corporates are now shifting their attention from days payables outstanding (DPO) to days sales outstanding (DSO), where improvements can have the greatest impact on the bottom line. A few days improvement in the DSO metric can translate into huge cost savings and drive greater efficiency in the working capital cycle.

Standardisation eases the pain

There are a host of reasons why A/R has proved a difficult process to address: multiple collection points and instruments, the absence of robust remittance data, truncated data and, in some cases, non-readable data received at the corporate end, are just a few examples. Also, the criticality of information on the receivables side should not be underestimated. In certain situations a companys reputation can be severely impacted by the late shipment of goods which may be held back pending receipt and prompt reconciliation of their customers payment. Standardisation is absolutely key and there is a continued effort between bank and corporate to enhance straight through reconciliation (STR). Industry initiatives such as SEPA or the move to ISO 20022 XML standards are helping with the process of automating reconciliation.

Current trends and best practices

Many companies have established SSCs and/or payment factories and, recognising the importance of the order-to-cash cycle, a number of companies are now managing their receivables processes in such facilities. Whilst corporates may be striving for the Holy Grail of 100% automated reconciliation, in practice this is often very difficult to achieve. Reconciliation is processed against specific predefined rules dictated by the setup of each corporates ERP/TMS workflow. We estimate that the current average STR rate is 65% across the largest multinational corporates, realised at the point of initial electronification of the reconciliation process. Moving from 65% to 85% should be the first goal for the treasurer, requiring increased automation and consolidation of the matching process. It is important that a bank continues to work closely with industry partners such as the local clearing houses and their corporate clients to develop solutions that promote automatic reconciliation and enhance the end-to-end experience of transaction banking. With the continued broadening and deepening of the treasurers role, treasury is now interfacing with other areas across the enterprise including credit control, sales and marketing functions to determine how to further improve efficiency. Those companies demonstrating best practice are setting metrics and measuring their performance in terms of DSO or best possible days sales outstanding (BPDSO) and then actively measuring their STR rate.

BPDSO measures the number of days that all companies take to collect revenue based on the exact payment terms agreed in the sales contract. It is an important metric against which to compare DSO performance. For example, a DSO of 100 may initially appear to be poor, but if the companys BPDSO is 90, then a DSO of 100 actually represents a good performance and identifies the gap of ten days during which the company can then focus on closing.

Moving from trapped cash to tracked cash

Earlier this year, Deloitte produced some analysis based on the financial statements of 20,000 companies across the globe, which suggested that UK public limited companies are sitting on 60 billion of unproductive working capital. This means that amount of money that companies require to fund day-to-day operations is being tied-up unnecessarily in a myriad of simple transactions. But what is preventing the release of this trapped cash? Optimisation of the STR process is a key response towards meeting this challenge of moving from trapped to tracked cash.

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Corporates continue to evolve the way they interface with their banking providers. Increasingly, they are seeking to apply information across their financial supply chain to enable transactions to be tracked, similar to the way a postal company tracks packages as they move around the world. This granular level of transaction reporting and tracking provides a corporate with the information needed to make decisions that ensure cash is mobilised to the right location in a timely fashion. True end-to-end automation can only be achieved if the data flowing through is complete and in a format that can be used across all of the corporates systems that connect to the data, which then consumes, processes and turns out results. Implementing an integrated STR solution is essential to improving the end-to-end experience of the transaction flow. This can be achieved through the following: Adopting use of ISO 20022 XML standards for information process flow. Integrating the reporting and handling of unmatched information into the workflow in an automated manner. Integrating the re-association of returns into the workflow in an automated manner. Monitoring of transaction flow with integrated debit and credit advice to enable automated workflow decision-making. Adopting use of virtual account structures to further consolidate electronic receivables.

Achieving an industry standard for tracked cash processes is still some way off, and may be considered nirvana once we get there. However, greater collaboration between banks, clearing houses, corporates and ERP/TMS vendors can go a long way to improving the STR industry average. For example, the enforced adoption of the creditor reference field within a SEPA payment should significantly improve STR in Europe. Further work is necessary to transport this across the global payments landscape.

Global analysis suggests that UK PLCs alone are sitting on 60 billion of unproductive working capital.

Improvements in the A/R process will help to achieve greater working capital efficiency. Treasurers understand the role that DSO and STR play, increasingly identifying these as key business reporting metrics. Further automation can be achieved through greater data enrichment, allowing information to flow deeper into the organisation to integrate the financial and physical supply chains.

Liquidity management: seeing things clearly

All treasurers aim to control and forecast their companys most valuable asset, its cash, to achieve business growth, help with funding and improve working capital management. This is often easier said than done, but according to Ahmet Bulutoglu, Liquidity Product Manager for Global Treasury Solutions, EMEA, Bank of America Merrill Lynch, treasury is right to maintain its focus on this vital area.

Taking control of the companys cash globally

The starting point for control of a companys cash is having accurate and timely information on balance and transaction data, which in turn drives strategic decisions. As such, visibility of cash balances across all subsidiaries, countries and bank relationships is key to efficient liquidity management.

Ahmet Bulutoglu
Liquidity Product Manager for Global Treasury Solutions, EMEA

Moreover, with external funding both expensive and difficult to secure, it is critical for corporates to have their cash in the right place at the right time, not just for current operations, but for future commitments too. So with dwindling resources and an ever increasing remit, how are treasurers managing to take control of their global cash?

Starting with the deployment of policies and procedures across the entire company to optimise working capital, corporates are increasingly seeking integrated, global cash and liquidity solutions, reflecting an enterprise-wide approach to the post-crisis treasury landscape. Given the reappraisal of relationship banks based largely on crisis-driven counterparty risk concerns and the subsequent redistribution of wallet share by corporates multi-bank solutions have also become essential to building a clear picture of where a companys cash is.
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Standardisation, accuracy, uniformity, visibility and timeliness are key attributes of any global reporting solution. Nevertheless, there are also basic requirements that are often overlooked when aiming to improve such processes. For example, the quality of the data produced by a system is heavily dependent on the quality of data that is fed in. Banks can help by creating the right client integration solutions in terms of what information they send back to the client. Not only can this assist with STR for example, it also supports cash flow forecasting.

Cash flow forecasting building blocks

There are some achievable steps that corporates can take to improve their cash flow forecasting and to ensure their data is timely, accurate, as uniform as possible and easy to interpret. These are: Ensure global visibility of operational cash. Encourage all business units and subsidiaries to forecast on a regular basis. Every part of the business, no matter how isolated, is critical to global visibility and uniformity. Effective information gathering to achieve reconciliation, cash positioning and variance analysis.

At first glance, this may seem like a wish list rather than a to-do list, but the emphasis here is on achievable. For the complexities concerning the regularities of forecasting, corporates could, for example, offer business units incentives for minimal variances between forecast and actuals. Corporates can also work with their primary cash management bank to evaluate the effectiveness of each of the above steps and to also share best practice in cash flow forecasting, which can help them meet these goals.

Best practice
Best practice starts with the basics: bank balances and transactions. Data should be clear and complete with categorised transaction information so it is easy and quick to determine whether the transaction is sales-, investment- or foreign exchange-related. Balances need to indicate whether they are ledger, available and/or value-dated. Information is required at the close of each business day so that the treasurer has a complete picture upon which to make any decisions the following day. Balances and transactions should be updated intra-day so as to provide as close to a real-time view as possible, particularly on large-value items where important investment and/or funding decisions may be required. Any liquidity structures should also be reported including pooled and/or swept balances, interest calculations and apportionment/ allocation of interest to pool participants and automatic investments to money market funds for example.

It is through the optimisation of an accurate cash flow forecast that treasurers will be able to determine precisely when funds are needed and over what period of time, with the knowledge sufficient cash is available.

Once the above has been consolidated, treasurers are given a basis upon which to develop some robust cash flow forecasting. A companys own customer relationship management (CRM) system could contain the pipeline information to source some of the information required to construct the forecasts. These, combined with data held in the companys ERP and/or TMS will then complete the forecasts by entity, currency and time horizon. At this point, the information supplied by the bank(s) becomes vital as it is used to compare forecasts with actuals, allowing variance analysis to be undertaken. STR, as mentioned previously, forms an integral part of the process and better forecasting leads to better risk and working capital management. With the information provided by a robust cash flow forecasting process, treasurers have an accurate picture of where their cash is. This is especially significant post-crisis given the focus on preservation of capital and the fact that liquidity drives business growth. Moreover, with todays increased costs of funding, cash is once again king, given that credit remains both expensive and not always readily available. It is through the optimisation of an accurate cash flow forecast that treasurers will be able to determine precisely when funds are needed and over what period of time, with the knowledge that sufficient cash is available.

Cash pooling considerations

Preservation of liquidity is an additional challenge for todays treasurer, in particular as companies become more global and move into unfamiliar territories. Take for example in-country accounts with multiple banks present. This may require a classic overlay type arrangement which utilises SWIFT message types MT940/942 and 101 for end-of-day/intra-day balance information and drawdown of funds in the local accounts.

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But while one company may be more than happy to operate from a suite of foreign currency accounts (FCAs) in a single location, another may choose to operate mirror accounts. Others may prefer notional pooling over physical cash concentration. Each is effectively trying to maximise efficiencies by reducing interest expenses, improving interest income and exercising control over the companys liquidity. These different approaches make it difficult to determine a global best practice liquidity structure. Naturally, the legal and regulatory landscape, in respect of notional pooling, varies by country, and other factors such as the single currency being used by several member states. This avoids the complication of currency conversion. Issues such as those below ought to be considered when setting up notional pooling structures or physical cash concentration/zero balancing or sweeping arrangements: Not all currencies/countries can be included. Intercompany loans are created. Withholding tax calculations. Any legal and regulatory restrictions. Central bank reporting. Early cut-off times. Interest allocation. Interest reporting. Need to demonstrate arms length. Single vs multi-legal entity structures.

Leveraging relationships
Banks recognise the need to help their clients through the above issues, especially as the legal and regulatory landscape varies by country. Some banks have gone one step further to provide an interest allocation service, and so removing the burden from the client corporates often have a manual process in place for this. Again, in line with banks focus on service quality and relationships, the aim is to reduce costs and improve efficiency for clients. Were it possible for a service provider to deliver a fully-integrated solution to address the challenges of cash and liquidity management, perhaps the treasurers role might become even more strategic? This would allow them focus on the competitive advantage that could be gained through having their companys cash in the right place at the right time. While this notion may seem idealistic, it brings the theme of banks sharing best practice with their clients full circle. So, just as treasury operations function at their best in an end-to-end, seamless manner; relationships between banks and their corporate clients are most productive in a collaborative, knowledge-sharing and ultimately, holistic environment. Put simply, the future of cash management lies not just in having the right structures and technologies, but also in having the right end-to-end, relationships in place.

Bank of America Merrill Lynch is one of the worlds largest financial institutions, providing a full range of banking, investing, asset management and other financial products and services. It is a leading global bank and wealth management franchise and a premier corporate and investment banking and capital market business, providing innovative services in M&A, equity and debt capital raising, lending, trading, risk management, research, and liquidity and payments management. Clients and customers can expect access to a comprehensive suite of world class products, services, and expertise from an organisation that serves clients through operations in more than 40 countries and has relationships with 99% of the US Fortune 1,000 companies and 85% of the Fortune Global 500. For additional information regarding Bank of America Merrill Lynch, please visit www.baml.com

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Bank of America Merrill Lynch is the marketing name for the global banking and global markets businesses of Bank of America Corporation. Lending, derivatives, and other commercial banking activities are performed globally by banking af liates of Bank of America Corporation, including Bank of America, N.A., member FDIC. Securities, strategic advisory, and other investment banking activities are performed globally by investment banking af liates of Bank of America Corporation (Investment Banking Af liates), including, in the United States, Merrill Lynch, Pierce, Fenner & Smith Incorporated and Merrill Lynch Professional Clearing Corp., all of which are registered broker dealers and members of FINRA and SIPC, and, in other jurisdictions, by locally registered entities. Investment products offered by Investment Banking Af liates: Are Not FDIC Insured May Lose Value Are Not Bank Guaranteed. 2011 Bank of America Corporation.