Treasury Management - Introduction to Treasury Management PDF

BAF 4302 TREASURY MANAGEMENT 1: INTRODUCTION TO TREASURY MANAGEMENT Dr. Nuruddeen Abba Abdullahi Department of Banking and Finance BUK  AN OVERVIEW OF TREASURY MANAGEMENT  Treasury Management - Concept  Goals of Treasury Management  Objectives of Treasury...

BAF 4302 TREASURY MANAGEMENT 1: INTRODUCTION TO TREASURY MANAGEMENT Dr. Nuruddeen Abba Abdullahi Department of Banking and Finance BUK  AN OVERVIEW OF TREASURY MANAGEMENT  Treasury Management - Concept  Goals of Treasury Management  Objectives of Treasury Management  Functions of Treasury Management  Treasury Department Activities  Scope of Treasury Management  Liquidity Management  Liquidity Management vis-a-vis Treasury Management  AN OVERVIEW OF TREASURY MANAGEMENT Treasury Management  Treasury generally refers to the funds and revenue at the disposal of the bank and day-to-day management of the same.  Treasury management is the art of managing, within the acceptable level of risk, the consolidated fund of the bank optimally and profitably.  Treasury Management can be understood as the planning, organizing and controlling holding, funds and working capital of the enterprise in order to make the best possible use of the funds, maintain firm‘s liquidity, reduce the overall cost of funds, and mitigate operational and financial risk.  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.  Treasury Management includes a firm's collections, disbursements, concentration, investment and funding activities. In larger firms, it may also include trading in bonds, currencies, financial derivatives and the associated financial risk management.  Treasury management is also defined as ‘the corporate handling of all financial matters, the generation of external and internal funds for business, the management of currencies, cashflows and complex, startegies, policies and procedures of corporate finance.  Treasury management generally deals with working capital management and financial risk management (including fo forex and interest rate management).  Today, banks dedicate whole departments responsible for treasury management and supporting their clients in this area.  For non-banking entities, the terms Treasury Management and Cash Management are sometimes used interchangeably, while, in fact, the scope of treasury management is larger and includes funding and investment activities as mentioned above.  Treasury management ensures that the business is accurately tracking its daily sales and payments in an effective manner, while also having sufficient liquidity to meet both expected and unexpected financial obligations.  It involves ensuring that proper funds are available with the company at the time of outflow required and also that funds are not kept untilised for a good long time...this requires investing/disinvesting funds in open ended mutual fund schemes.  Treasury management is an important aspect of many corporations‘ financial management. It ensures the business is accurately tracking its daily sales and payments in an effective manner, while also having sufficient liquidity to meet both expected and unexpected financial obligations.  International companies must keep track of a variety of regulations impacting them from different locales – each has to be correctly tended to in order to ensure a prosperous business.  Also, treasury managers need to remain aware of local regulations that can change quickly and substantially in smaller regions. The most substantial new regulation affecting the financial sector, and particularly the treasury management industry, is Basel III.  A treasurer’s primary duty, or responsibility, to ensure that the company can meet its financial obligations as they fall due, including payments to suppliers, employees, tax authorities, shareholders, banks and bond holders. Financial obligations can be in a variety of currencies, so cash needs to be available at the right time, in the right place, and in the right currency Goals of Treasury Management  The key goal of treasury management is planning, organizing and controlling cash assets to satisfy the financial objectives of the organization.  The goal may be to maximize the return on the available cash, or minimize interest cost or mobilize as much cash as possible for corporate ventures. The goals of treasury management include: 1. Maximise the return on available cash 2. Minimise interest cost on borrowings 3. Mobilise as much cash as possible for corporate ventures (in case of need) 4. Financial risk management through effective dealing in forex, money and commoditiy markets to reduce risks arising from fluctuations in exchange rates, interest rates, and prices which can affect the profitability of the entity.  Objectives of Treasury Management 1. Maintaining Liquidity - making sure that the business has sufficient liquidity to meet its obligations, whilst managing payments, receipts and financial risks effectively. 2. Optimizing Cash Resources - corporate entities need to ensure that their financial position is managed as efficiently as possible, with no excess working capital tied up in the business, hence the old adage ‘cash is king‘! 3. Establishing and Maintaining Access to Short-Term Financing 4. Maintaining Access to Medium- and Long-Term Financing 5. Maintaining Shareholder Relations 6. Managing Risk 7. Coordinating Financial Functions and Sharing Financial Information  The Treasury function in any corporate entity is always important in making sure that the business has sufficient liquidity to meet its obligations, whilst managing payments, receipts and financial risks effectively.  Treasury departments need to cover the complete financial environment; from capital structure and long term investments to liquidity and working capital management. If Treasury can drive improvements in the Purchase-To-Pay and Order-To Cash cycles, there can be a direct effect on the overall debt and investment requirements and thus on the capital structure required in the business.  Cash and liquidity management has always been a key task in every company to ensure debtor, creditor and stock levels are managed as efficiently and effectively as possible. When the business environment is more challenging, corporates can gain a competitive advantage through optimal management of every aspect of their financial position.  Functions of Treasury Management  Basically, treasury functions revolve around the monitoring of cash, the use of cash, and the ability to raise more cash. All other tasks of the department support these functions.  Most banks have whole departments devoted to treasury management and supporting their clients' needs in this area.  Generally, the treasury department is responsible for managing the liquidity of a business by monitoring all current and projected cash inflows and outflows to ensure that there is sufficient cash to fund company operations, as well as to ensure that excess cash is properly invested.  In accomplishing the responsibility, the treasurer must engage in considerable prudence to ensure that existing assets are safeguarded through the use of safe forms of investment and hedging activities.  The functions of treasury management are: 1. Cash Management: Treasury Management includes cash management, and so it ensures that there are an effective collection and payment system in the organization. 2. Liquidity Management: An optimum level of liquidity should be maintained in the business, for the better and smooth functioning of the business, i.e. the company must be able to fulfil its financial obligation when they become due for payment, such as payment to suppliers, employees, creditors, etc.And to do so, cash flow analysis and working capital management act as the most important tool for treasury management, to achieve its strategic goals. 3. Availability of funds in adequate quantity and at the right time: The treasury manager has to ensure that the funds are available with the organization in sufficient quantity, i.e. neither be more nor less, to fulfil the day to day cash requirement for the smooth functioning of the enterprise. Further, timely availability of funds also smoothens the firm‘s operations, resulting in the certainty as to the amount of inflows available with the company at a particular point in time. 4. Deployment of funds in adequate quantity and at the right time: The deployment of funds has to be done in right quantity such as the acquisition of fixed assets, purchase of raw material, payment of expenses like rent, salary, bills, interest and so forth. For this purpose, the treasury manager has to keep an eye on all receipts of funds and the application thereof. Further, the funds must be available at the time of need, which may be different for different firms and also for the purpose for which they are used. The period may differ from a week to month when it comes to acquisition of the fixed assets and two to three days in case of working capital requirement. 5. Optimum utilization of resources: Treasury Management also aims at ensuring the effective utilization of the firm‘s resources, to reduce the operating costs and also prevent liquidity shortage in the coming time. 6. Risk Management: One of the primary objectives of the treasury management is to manage financial risk to allow the enterprise to meet its financial obligations, as they fall due and also ensure predictable performance of the business. It tends to identify, measure, analyze and manage risk in order to mitigate losses that has the potential to affect the company‘s profitability and growth in any way.Hence, treasury management is accountable for all types of risk that can influence the business entity.  Further, the treasury management intends to maximize return on the funds available with the company, by making such investments which have higher return and low risk. Treasury Department Activities:  In order to accomplish its mission, the treasury department must engage in the following activities: 1. Cash forecasting. Compile information from around the company to create ongoing cash forecast. This information may come from the accounting records, the budget, capital budget, board minutes (for dividend payments) and even the CEO (for expenditures related to acquisitions). 2. Working capital monitoring. Review the corporate policies related to working capital, and model their impact on cash flows. For example, looser credit results in a larger investment in accounts receivable, which consumes cash. 3. Cash concentration. Create a system for funneling cash into a centralized investment account, from which cash can be most effectively invested. This may involve the use of notional pooling or cash sweeps. 4. Investments. Use the corporate investment policy for allocating excess cash to various types of investments, depending on their rates of return and how quickly they can be converted into cash. 5. Credit granting. Issue credit to customers, which involves management of the policy under which credit terms are granted. 6. Fund raising. Determine when additional cash is needed, and raise funds through the acquisition of debt, sale of stock, or changes in company policies that impact the amount of working capital required to run the business. 7. Risk management. Use various hedging and netting strategies to reduce risk related to changes in asset values, interest rates, and foreign currency holdings. 8. Credit rating agency relations. Keep any credit rating agencies informed of the company's financial results and condition, if these agencies are providing ratings on the company's marketable debt issuances. 9. Bank relations. Keep the company's bankers apprised of the company's financial condition and projections, as well as any forthcoming changes in its need for borrowed funds. The discussion may extend to the various services provided by the banks to the company, such as lockboxes, wire transfers, and so forth. 10. IT systems. The department maintains treasury workstations that provide it with information about cash holdings, projections, market conditions, and other information. 11. Reporting. The treasurer provides the senior management team with reports concerning market conditions, funding issues, returns on investment, cash-related risks, and similar topics. 12. Mergers and acquisitions. The department may advise on the company's acquisition activities, and may be called upon to integrate the treasury functions of entity being merged.  In essence, treasury functions revolve around the monitoring of cash, the use of cash, and the ability to raise more cash. All other tasks of the department support these functions.  Scope of Treasury Management  A treasury department is to control and manage the bank's money (in terms of capital and liquidity) and to make sure that all parts of the bank can readily access the cash they need for their business activities.  Liquidity Management involves: i. Money Market Transaction ii. Capital Market Transaction iii. Corresponding Banking iv. Foreign Exchange v. Rate Detarmination LIQUIDITY MANAGEMENT  The objective of liquidity management is to maintain adequate level of liquidity and raise profitability of the bank managing the surplus liquidity.  Bank will follow raising cash on short notice with low cost as possible in shortage of funds and convert funds in earnings assets if surplus funds are available.  In the situation of surplus liquidity, the treasury should use in money market lending, buying T-bills, and government securities. Money Market Transaction  Money market is market where short term security with high liquidity are traded.  It is used as a means for borrowing and lending in the short term basis i.e. one year or less than one year.  The investment in Treasury bills shall be done for the purpose of maintaining statutory liquidity ratio and managing returns and liquidity.  The treasury department will purchase the Treasury bill within the approved limits. Capital Market Transaction  Capital markets are the market where long term securities are traded - buying and selling of debt and equity instruments.  This type of market is composed of the both the primary and secondary markets.  Treasury department shall make the long-term investment in capital market instruments like government bond, corporate bonds, preference shares and equity shares.  Corresponding Banking  Correspondent banking provides credit, deposit, collection, clearing and payment services to banks and financial institutions.These types of services are limited to bank and financial institutions.  Foreign Exchange Management  The foreign exchange market or forex market as it is often called is the market in which currencies are traded.  The value of one currency is determined by its comparison to another currency. The first currency of a currency pair is called the ― base currency, while the second currency is called the counter currency. The currency pair shows how much of the counter currency is needed to purchase one unit of the base currency.  Rate Determination  Treasury should use two way pricing system to publish rates. Normally, price will be moved freely on the basis of the forces of demand and supply in the market.  Dealers are responsible for issuing daily exchange rates of each convertible foreign currency. These are fixed against local currency (Naira) at the start of the business each morning. The spread of buying and selling rate would be as determined by the authority. Dealers will issue revised rates during the business hours if market conditions change significantly. TREASURY CONTROL MECHANISM  Treasury management relates to most of the highly volatile instrument’s market dealing.  The volume of transactions involved in the dealings are usually heavy and risk in operation are also heavy. So any inorganization operation will create heavy loss for the institution.  Generally control system may be related to: a. Internal control of different, dealing rooms, settlement offices and control offices. b. Checking of unhealthy insider trading system. c. Mutual and ammicable solution of different conflicts of interest in dealing operation.  Internal Control System  It relates to forming policies to check leakage of profit for the institution.  In treasury operation, the role of Central Offices are vital. They should form suitable guidelines for the institution in respect of various treasury dealing operations.  There are advice dealing offices to categorise all treasury items into different classes according to risk involvement.  As treasury business is a risky business responsible positioned persons should be delegated powers to deal in treasury operation with imposition of different limits on their discretionary power.  Some important area should be taken (i) fixation of rates for each treasury items and (ii) fixing limits for dealers to deal with different counterparties, with proper observation of confidentiality and adherance to best market practice.  Treasury executive should ensure that the transactions are carried in correct manner by cross checking during each dealing day.  For above facts the central offices should develop proper policies and guidelines for treasury operation and should advice the dealers to deal according to policies of the following : i. restriction on deal in one’s own account. ii. timely advice to dealing offices in respect of any adverse transactions received or excess reporting. iii. timely submission of returns to different statutory authorities. iv. review of security and contingency arrangement of different offices..26 v. proper verification of compliance given by lower offices for irregularities.  Insider Dealings  Insiders are those who are in management including near and dear; and their dealings means-taking advantages of unpublished internal informations of the corporate body. These may create price advantages to the insiders against other shareholders.  So avert such dealings a properly efficient internal control system should be taken by the management to eliminate insider dealing by fixing penalties for insider dealers.  LIQUIDITY MANAGEMENT VIS-A-VIS TREASURY MANAGEMENT  Liquidity management ensures that the right amount of cash is available, at the right time and in the right place, is firmly positioned as a pivotal task for every treasurer.  Over the past few years, many treasurers have made substantial progress towards increasing the visibility of their cash flow and centralising cash within countries or regions.  However, industry surveys indicate year on year that liquidity management and particularly cash flow forecasting remain the greatest challenges facing treasurers.  With credit more expensive and elusive for many companies, it is now imperative to tackle these challenges effectively.  Working capital management of a financial institution or bank or company is some how different to that of other trading units, the process starts with tapping of funds at lower rate in shape of deposits/borrowing and ends with investing the same in higher rate to earn profit out of business with a margin of small portion of cash-in-hand kept to meet day to day operation.  Efficient account and cash pooling structures are key to efficient and cost- effective liquidity management.  Every investment has a cost to the company even the shares tapped from the share holders. Deposits are tapped in exchange of payment of interest. Borrowing has cost of payment of interest to creditors. So every fund has dividend/interest payment risks for the banks/company. So if funds tapped are not properly utilized, the banks/ company should suffer loss. Idle cash balance in hand has no yield.  On the other hand if we do not keep balanced liquid cash-in-hand, we may not be able to pay the demand withdrawal of depositors, as well as, installment of creditors and untimely payment for other contingent liabilities. These will lead overtrading position to the company. So there must be a scientific liquidity management policy for the company/bank/financial institution.  Proper liquidity management can increase the turnover of business and also creates additional profit to the company/banks.  Liquidity management has great significance in modern days to the company/bankers/financial institution, because they engage not only in retail business, but also deal in wholesale banking and investment banking business.  Overliquidity on the other hand implies excess idle cash balance in hand. So every company should avoid both the position and should manage the company without less/excess funds in hand i.e. just liquid position. Thank You! Question bank 1. Why management of money is needed? 2. Mention the objectives of treasury management. 3. Examine the statement –treasury department effectively deals with capital market transactions. 4. Explain the key benefits of planning and operations of treasury management. 5. Compare liquidity management and treasury management. 6. Summarize the functions of treasury management. 7. Evaluate the activities involved in treasury department..32