Lessons for treasury management from the financial crisis

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1 NOVEMBER 2011 AlixPartners Viewpoint Lessons for treasury management from the financial crisis By Matthew Johnston, Director, AlixPartners and Phil Lawrence, Vice President, AlixPartners Since the onset of the global economic crisis, companies have accumulated record levels of cash. In Europe, cash comprises 12% of total assets on corporate balance sheets almost a third higher than at any point in the last economic cycle. 1 As a result, treasury management has gained a much higher level of importance within corporate strategy. For the treasury management function to generate maximum value, it must work seamlessly with all areas of the business, with processes adapted to create an integrated and holistic approach. A PARADIGM SHIFT: THE KEY TO SURVIVING THE FINANCIAL CRISIS From 2008 to 2010, management teams understandably focused more on cash flow and liquidity than on more traditional performance indicators like sales or EBITDA. Managing payment streams, ensuring ready liquidity, allocating cash effectively, and closely monitoring cash flows became a matter of life and death for many businesses. To accomplish this, management required detailed and timely answers to questions about the security of future cash flows, the level of current liquidity, potential liquidity risks and the feasibility of liquidity release. Lending from banks or other intermediaries was severely limited, making it critical for CFOs to focus on internal sources of financing and liquidity. As a result, the treasury department, often operating out of the spotlight, had to move to centre stage, and frequently had to develop additional skills. 1 UBS Investment Research, 2011.

2 2 MUCH MORE THAN PAYMENT PROCESSING Generally, the treasury department focuses on payment flows including reconciling incoming payments, ensuring adequate liquidity, and managing financial risk. Typically in larger organisations it comprises three areas: a front office that conducts financial transactions, a back office that executes and records these transactions, and a middle office that is responsible for financial controlling. But the structure of the treasury department varies widely between small and mediumsized entities (SMEs) and large corporations. In large, multinational organizations, the importance of the treasury department, with its tri-partite front/middle/ back-office structure, is already well established. In SMEs, often, the treasury department is made up of just one or two people, and its job is simply to process payments, making it effectively an adjunct to credit control. Without question, in times of crisis it remains important to process payments in a cost-effective way that contributes to the company s liquidity. However, excellent treasury management is about much more than just this. Of course, ensuring that electronic payment systems meet the company s speed and security requirements, and processing inter-company payments, will always remain a central part of the treasury department s work, but optimal treasury management also involves: Gaining clear visibility into current and planned payment flows Managing risks such as: Customer or supplier defaults; Currency and interest-rate hedging; and Security of raw material supply. Generating liquidity at all levels through: Working capital optimisation; and Opening credit lines. Ensuring appropriate financing is in place to meet longer term strategic commitments. Of course, processes that are relevant to a company s liquidity affect many different areas of the organisation negotiation of loans, delinquency management within the credit control function, or even inventory management in production and logistics. As a result, the treasury management must be organised and run in such a way as to facilitate close integration with other areas of activity. THE NEXUS OF HOLISTIC COMPANY CASH MANAGEMENT If the treasury department is to function as a guarantor of liquidity for the company as a whole, its mandate must be expanded from the on-demand provision of financial resources to include the active management of all cash-relevant issues. This means not only taking into account the various interdependencies with other parts of the company, but also working closely together with the following functions in particular: Financial controlling: assisting with financial planning, especially when producing a short-term 13-week cash flow plan. This has proven to be the best tool for transparent liquidity management, as liquidity is calculated directly from incoming and outgoing payments, as opposed to being derived from the P&L forecasts and the balance sheet. In many cases, the financial controlling department s monthly plans follow the treasury department s 13- week cash flow plan.

3 3 Sales: assessing the credit risk of customers, setting credit limits and individual payment terms, handling foreign currency payments, and hedging against exchange rate fluctuations etc. Purchasing: setting objectives for negotiating payment terms with suppliers based on the specific liquidity situation, foreign-currency purchasing and hedging, handling letters of credit for imports, raw-material hedging, and arranging performance securities. Production: monitoring levels of inventory and the liquidity tied up in it. When involved in the management of domestic subsidiaries, the central treasury department should handle all payment transactions for the subsidiaries and provide them with liquidity as required for local expenses. Often, subsidiaries are involved in cash-pooling arrangements, which again the treasury department is responsible for managing. When done properly, this puts all the group s cash reserves under effective central control, enabling management to prioritise the allocation of the available liquidity. And while this knowledge is always important, it is absolutely critical during difficult economic times. FULL IMPLEMENTATION NO HALF MEASURES The financial crisis clearly demonstrated how vital visible and effective centralised management of liquidity is to a company s success or even survival. The crisis shone a merciless spotlight on existing shortcomings: capacity or skills shortages, inadequate risk management systems, deficient IT infrastructure, and fundamental defects in back-office processes. Consequently, many companies have resolved to focus much more closely on treasury management and to invest in both staff and software. Though this is a step in the right direction, it is not enough. Business processes throughout the company must also be systematically reviewed and adapted. The full potential of treasury management can only be realised through a holistic approach involving all relevant areas of the company and the prerequisite for this is a carefully prepared implementation plan and a critical analysis of staff skill sets.

4 4 DOES YOUR COMPANY HAVE SUFFICIENT VISIBILITY INTO ITS CASH SITUATION? SIX KEY AREAS OF FOCUS. 1. CASH MANAGEMENT 2. EXTERNAL FINANCING 3. WORKING CAPITAL 4. TRANSPARENCY AND MONITORING Can we do the following? 5. MAXIMUM CASH GENERATION 6. CASH AS STRATEGIC WEAPON What certainty do we have over the size and transparency of future cash flows? Do we understand the scenarios in which unpleasant surprises could occur? How would we cope in these scenarios? Do we have a detailed understanding of our banking covenants and how they operate? Do we know how much liquidity we have available and how much we actually need? Is our financing structure consistent with our strategy and business model? How much liquidity can we generate in the short and medium term from working capital activities? Develop realistic and sensitised cash forecasts? Implement robust 13-week liquidity planning (processes, tools, responsibilities, reporting)? Measure cash generation/burn rate by product, sales channel, customer, business area? Calculate available liquidity? Evaluate covenant scenarios and adjust financing arrangements if necessary? Optimize cash pooling and intercompany financing to reduce trapped cash? Produce credit assessments for customers and suppliers? Appropriate working capital management Receivables/payables Optimise inventory Investment management Prioritisation Staggering of projects Optimisation of asset base Divestments Site consolidations Reduction in expenditure Reduction in discretionary expenditure Focus on cash conversion, considering the desire to maximise sales and pricing Focus on cash-generating products, customers, sales channels, countries and areas of business Leverage strong cash position to gain market share from cash-poor competitors Prepare for global market changes: acquire technologies/talent/product lines/business units from cash-poor competitors Consolidate market position through M&A activities Source: AlixPartners

5 5 Matthew Johnston was one of the founding members of the AlixPartners team in Europe joining in Since then he has worked on major restructurings, including Refco and Southern Cross, and has also performed hands-on restructuring roles for several mid-tier companies, including JAL Group, ILVA and Dorling Kindersley. In 2007, he took the CFO role at Titan Outdoor Advertising and returned to AlixPartners in 2010 following the sale of that business to JC Decaux. Contact: +44 (0) Phil Lawrence has been with AlixPartners since 2009 during which time he has undertaken an interim treasurer role at a UK listed insurer and other advisory engagements. Prior to AlixPartners, he worked in the leveraged work out team at HBoS leading a variety of high profile restructurings including IMO Carwash. He started his career at KPMG Restructuring focussing on cash and working capital management as well as lender advisory roles. Contact: plawrence@alixpartners.com +44 (0) AlixPartners conducts a broad range of surveys and research in industries around the globe. To learn more about our publications, or to contact the AlixPartners professional nearest you, please visit AlixPartners is a global firm of senior business and consulting professionals that specializes in improving corporate financial and operational performance, executing corporate turnarounds and providing litigation consulting and forensic accounting services when it really matters in urgent, high-impact situations.