Treasury

The treasury function of a firm usually has the following roles within the context of financial management:

Short-term management of resources

• Short-term cash management - lending/borrowing funds as required.
• Currency management.

Long-term maximisation of shareholder wealth

• Raising long-term finance, including equity KFKBstrategy, management of debt capacity and debt and equity structure.
• Investment decisions, including investment appraisal, the review of acquisitions and divestments and defence from takeover.
• Dividend policy.

Risk management

• Assessing risk exposure.
• Interest rate risk management.
• Hedging of foreign exchange risk.

Treasury: cost centre or profit centre?

As a cost centre the aggregate treasury function costs would simply be charged throughout the group on a fair basis. If no such fair basis can be agreed, the costs can remain as central head office unallocated costs in any group segmental analysis.

However it is also possible to identify revenues arising from treasury departments and thus to establish the treasury as a profit centre. Revenues could be realised as follows:

• Each division can be charged the market value for the services provided by the treasury. The total value charged throughout the group should exceed the treasury's costs enabling it to report a profit.
• By deciding not to hedge all currency and interest rate risks. Experts in the treasury could decide which risks not to hedge, hoping to profit from unhedged favourable exchange rate and interest rate movements.
• Hedging using currency and interest rate options leaves an upside potential which could be realised if the rate moves in the company's favour.
• Taking on additional exchange rate or other risks purely as a speculative activity, e.g. writing options on currencies or on shares held.

The trend in recent years has been for large companies to turn their treasuries from cost centres into profit centres and to expect the treasury to pay its way and generate regular profits each year.

However the following points should be noted:

• A treasury engaged in speculation must be properly controlled by the company's board of directors. Millions of dollars can be committed in one telephone call by a treasurer, so it is crucial that limits are set on traders' risk exposures and that these limits are monitored scrupulously. The temptation has been for directors to let treasurers "get on with whatever they do" as long as regular profits are being earned. Such a policy is no longer acceptable; the finance director in particular must control the treasury on a day-to-day basis.
• For example, in 1993 the German oils and metals company Metallgesellschaft managed to lose $1 billion after becoming over-exposed to oil derivative contracts.
• Treasury staff must be well trained and probably well paid, so that staff of the right calibre can be secured.
• The low volume of foreign currency transactions undertaken by a small company would probably make a profit centre approach unviable. A regular flow of large foreign transactions is needed before the cost centre approach is abandoned.

The international treasury function

The corporate treasurer in an international group of companies will be faced with problems relating specifically to the international spread of investments.

• Setting transfer prices to reduce the overall tax bill.
• Deciding currency exposure policies and procedures.
• Transferring of cash across international borders.
• Devising investment strategies for short-term funds from the range of international money markets and international marketable securities.
• Netting and matching currency obligations.

The centralisation of treasury activities

The question arises in a large international group of whether treasury activities should be centralised or decentralised.

• If centralised, then each operating company holds only the minimum cash balance required for day to day operations, remitting the surplus to the centre for overall management. This process is sometimes known as cash pooling, the pool usually being held in a major financial centre or a tax haven country.
• If decentralised, each operating company must appoint an officer responsible for that company's own treasury operations.

Advantages of centralisation

• No need for treasury skills to be duplicated throughout the group. One highly trained central department can assemble a highly skilled team, offering skills that could not be available if every company had their own treasury.
• Necessary borrowings can be arranged in bulk, at keener interest rates than for smaller amounts. Similarly bulk deposits of surplus funds will attract higher rates of interest than smaller amounts.
• The group's foreign currency risk can be managed much more effectively from a centralised treasury since only they can appreciate the total exposure situation. A total hedging policy is more efficiently carried out by head office rather than each company doing their own hedging.
• One company does not borrow at high rates while another has idle cash.
• Bank charges should be lower since a situation of carrying both balances and overdraft in the same currency should be eliminated.
• A centralised treasury can be run as a profit centre to raise additional profits for the group.
• Transfer prices can be established to minimise the overall group tax bill.
• Funds can be quickly returned to companies requiring cash via direct transfers.

Advantages of decentralisation

• Greater autonomy leads to greater motivation. Individual companies will manage their cash balances more attentively if they are responsible for them rather than simply remitting them up to head office.
• Local operating units should have a better feel for local conditions than head office and can respond more quickly to local developments.

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Tags:	treasury;financial management