treasury management in corporates

TREASURY MANAGEMENT
IN CORPORATES

TREASURY MANAGEMENT
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
22/18/2016

IN CORPORATES
 To maintain the liquidity of business
 Develops and executes all capital market activity
 Manages the financial risks of the company
 Implementing company’s optimal capital structure
 To provide quick finance to Company
32/18/2016

TREASURY MANAGEMENT
42/18/2016
Working
Capital
Management
Cash
Management
Financial
Risk
Management
Capital
Markets and
Funding
Corporate
Financial
Management
Treasury
Management

SIGNIFICANCE OF CASH MANAGEMENT
• Cash – “Life blood of a business”
 Motives of holding cash
Transactions Motive
Precautionary Motive
Speculative Motive
62/18/2016

CASH PLANNING
 Cash Planning is a technique to plan and control the use of cash
 Cash Forecasting and Budgeting
 Cash budget is the most significant device to plan for and control cash
receipts and payments
 Cash forecasts are needed to prepare cash budgets
72/18/2016

2/18/2016 8
TYPES OF CASH
FORECASTING
SHORT TERM LONG TERM

METHODS OF CASH BUDGETING
92/18/2016
• Receipts and Payments Method
Shows timing and magnitude of expected cash receipts and payments over
forecast period
Advantages:
It gives a complete picture of all the items of expected cash flows.
Limitations:
 Its reliability is reduced because of the uncertainty of cash forecasts
 It fails to highlight the significant movements in the working capital
items

2/18/2016 10
Month Month Month
Balance b/d ( 1 )
Receipts
Cash Sales
Credit Sales
Bank Loans
Other Receipts
Total Receipts ( 2 )
Payments
Cash and Credit Purchases
General and Admin Expenses
Tax payments
Interest payments
Dividends
Investment in short term securities
Total Payments ( 3 )
Net Cash Flow ( 2 - 3 )

ADJUSTED NET INCOME METHOD
• Adjusted Net Income Method
 This method involves tracing of working capital flows
 It is also called as the Sources & Uses approach
 It generally has 3 sections: Sources, Uses & Adjusted cash balance
Objectives:
 To project company’s need for cash at a future date
 To show whether company can generate funds internally
2/18/2016 11

2/18/2016 12
Year Year Year
Cash beginning of year
Sources of Cash
Net Income
Non cash charges
Increase in Borrowing
Sale of equity shares
Miscellaneous
Total ( 1 )
Uses of Cash
Capital Expenditures
Increase in Current Asset
Repayment of borrowings
Dividends Payments
Total ( 2 )
Surplus/ Deficit ( 1 – 2 )

Advantages:
It highlights the movements in the working capital items, and thus helps to
keep a control on a firm’s working capital
Limitations:
It fails to trace cash flows, and therefore, its utility in controlling daily cash
operations is limited
2/18/2016 13

CASH COLLECTIONS AND DISBURSEMENTS
2/18/201614

FLOAT
Float : Difference between the available balance and book balance of company
Float Time is the time between a customer initiating a payment and the company
being informed that it has obtained value at the bank
 Types of Float:
 Payment or Disbursement Float
 Availability or Collection Float
 Net Float
152/18/2016

2/18/2016 16
• Cheques issued by a firm creates Disbursement Float
Eg : Bharat Company
• On 1st April it pays 1 million by cheque to one of its suppliers
• Disbursement Float = Firm’s available balance – Firm’s book balance
= Rs 1 million
On 31st March
Book Balance Rs. 4 million
Bank Balance Rs. 4 million
On 1st April

2/18/2016 17
• Cheques received by a firm creates Collection Float
Eg : Bharat Company
• On 1st May it receives a cheque for 1.5 million from customer
• Collection Float = Firm’s available balance – Firm’s book balance
= Rs -1.5 million
On 30th April
On 1st May
Book Balance Rs. 6.5 million

2/18/2016 18
• Net Float = Disbursement Float + Collection Float
Disbursement float > Collection float.
Positive Float, Available balance > Book Balance
Disbursement float < Collection float
Negative Float, Available balance < Book Balance
If the company has a positive net float, it may issue more cheque amounts, even
though the balance as per its book is lower.
So, a company that has a positive net float at a point of time can effectively use and
manage the float in such a way that it can maintain a smaller cash balance.

SPEED UP COLLECTIONS
• Collection Time
192/18/2016
Customer
mails the
cheque
Company
receives the
cheque
Company
deposits the
cheque
Cash
available
Mailing
Time
Processing Availability
delay

 Concentration banking
Company asks its customer in a particular area to send payments to a local branch
office rather than to the corporate HQ
2/18/2016 20
Clients pay in
Local branch
office instead
Company’s HQ
Deposit cheque
into Local bank
A/c
Surplus Funds are
transferred to
Concentration
A/c

 Lock boxes
Customers are advised to mail their payments to special post office boxes
called lockboxes, which are attended to by local collecting banks, instead of
sending them to corporate headquarters
• Cuts down the mailing time
• Reduce the processing time
• Shortens availability of delay
2/18/2016 21

Corporate
Customer
Corporate
Customer
Corporate
Customer
Corporate
Customer
Local banks
collect funds
Separation of
cheques and
receipts
Cheque
deposited in
banks
Bank clears
cheques
Post office box 1 Post office box
2
Details of
receivable go to
firm
Firm processes
receivables 2/18/2016 22

2/18/2016 23
Avg. number of daily payments to Lock Box 150
Avg. size of payments Rs. 1200
Rate of Interest per day 0.02 %
Saving in Mailing time 1.2 days
Saving in Processing time 0.8 day
Thus, the Lock Box would increase the collected balance by:
150 (payments per day) * Rs. 1200 (Avg. Payment) * (1.2 + 0.8) days saved = Rs.360,000
Invested at 0.02% per day, gives a daily return of:
0.0002 * Rs. 360,000 = Rs. 72
If bank charges 0.26 per check , i.e. 0.26 * 150 = Rs. 39 per day
Net gain is Rs.72 – Rs. 39 = Rs. 33
Favorable to have Lock Box

 Electronic Fund Transfer
• Online based transaction from one bank account to another
• Reduces the time taken to carry out a transaction
• RTGS and NEFT
• Wire transfer for International transactions (SWIFT)
2/18/2016 24

OPTIMUM CASH BALANCE
 Enough in order to make payments when needed
 Additional cash for unexpected requirements
Two Models for Optimum Cash Balance
 Under certainty –
Baumol’s model
 Under uncertainty -
Miller-Orr model
252/18/2016

BAUMOL’S MODEL
 William J. Baumol developed a model (The transactions Demand for Cash : An
Inventory Theoretic Approach) which is usually used in Inventory
management & cash management.
 It Trade off between opportunity cost or carrying cost or holding cost &
Transaction cost
 As such firm attempts to minimize the sum of the holding cash & the cost of
converting marketable securities to cash
262/18/2016

2/18/2016 27
 The firm is able to forecast its cash needs with certainty
 The firm’s cash payments occur uniformly over a period of time
 The opportunity cost of holding cash is known and it does not change over
time
 The firm will incur the same transaction cost whenever it converts securities
to cash
Baumol’s Model–Assumptions

F = The fixed cost of selling securities to raise cash
T = The total amount of new cash needed
K = The opportunity cost of holding cash: this is the interest rate.
If we start with $C, spend at a
constant rate each period and
replace our cash with $C when
we run out of cash, our average
cash balance will be
2
C
The opportunity cost of
holding is
2
C
K
C

2
2/18/2016 28

F = The fixed cost of selling securities to raise cash
T = The total amount of new cash needed
K = The opportunity cost of holding cash: this is the interest rate.
As we transfer $C each period
we incur a trading cost of F each
period. If we need T in total
over the planning period we
will pay $F, T ÷ C times.
The trading cost is F
C
T

2/18/2016 29

C*
Size of cash balance
F
T
K
C

C2
costTotal
Opportunity
Costs
K
C

2
F
T

C
Trading
costs
The optimal cash balance is found where the opportunity
costs equal the trading costs
F
K
T
C 
2*
2/18/2016 30

Limitations :
 The model assumes the firm has a constant disbursement rate
 The model assumes there are no cash receipts during the projected
period
 Treasurers may want a ‘safety stock’ for cash
2/18/2016 31

THE MILLER-ORR MODEL
The firm allows its cash balance to wander randomly between upper and lower
control limits.
The models answers the following questions:
When should transfers be effected between marketable securities and cash?
What should be the magnitude of these transfers?
Assumptions:
There is no underlying trend in cash balance over time
The optimal values of LL and RP depend not only on the fixed and opportunity
costs but also on the degree of likely fluctuations in cash balances

LL – Set By Management
RP =
3 3𝑏𝜎2
4𝐼
+ LL
UL = 3RP – 2LL
2/18/2016 33

NETTING
 A process where instead of settling each separate transaction, the
company creates a netting center
 This acts like a clearing house that adds & subtracts the various
amount of inter subsidiary payables & receivables
 At the end of month, each subsidiary pays or collects one net
payment from the netting center.
352/18/2016

BILATERAL NETTING: AN EXAMPLE
Consider a U.S. MNC with three divisions and the
following foreign exchange transactions:
$10 $35 $40$30
$20
$25
$60
$40
$10
$30
$20
$30
362/18/2016

Bilateral Netting would reduce the number of foreign exchange
transactions as follows; Examine U.S and Canadian affiliate
$10 $35 $40$30
$20
$25
$60
$40
$10
$30
$20
$30
372/18/2016

Bilateral Netting: U.S. and Canada net out at $10
$10 $35 $40$30
$25
$60
$40
$10
$10
$20
$30
382/18/2016

Bilateral Netting: Canadian and U.K. affiliates.
$10 $35 $40$30
$25
$60
$40
$10
$10
$20
$30
392/18/2016

Bilateral Netting: Canadian and U.K. affiliates net out
at $10
$10 $35 $10
$25
$60
$40
$10
$10
$20
$30
402/18/2016

Bilateral Netting: U.K. and German affiliates.
$10 $35 $10
$25
$60
$40
$10
$10
$20
$30
412/18/2016

Bilateral Netting: U.K. and German affiliates net out
at $10
$10 $35 $10
$25
$60
$40
$10
$10
$10
422/18/2016

Bilateral Netting: U.S. and German affiliate.
$10 $35 $10
$25
$60
$40
$10
$10
$10
432/18/2016

Bilateral Netting: U.S. and German affiliate net out at
$25.
$25 $10
$25
$60
$40
$10
$10
$10
442/18/2016

Bilateral Netting: U.S. and U.K. affiliate.
$25 $10
$25
$60
$40
$10
$10
$10
452/18/2016

Bilateral Netting: U.S. and U.K. affiliate net out at $20.
$25 $10
$25
$20
$10
$10
$10
462/18/2016

Bilateral Netting: German and Canadian affiliates.
$25 $10
$25
$20
$10
$10
$10
472/18/2016

Bilateral Netting: German and Canadian affiliates net
out at $15
$25 $10
$15$20
$10
$10
482/18/2016

BILATERAL NETTING
 Before bilateral netting:
 Total funds (gross) to be moved: $350
 With bilateral netting:
 Total funds (net) to be moved: $90
 This is a reduction of $260 in foreign exchange transactions.
492/18/2016

MULTILATERAL NETTING: AN EXAMPLE
Consider simplifying the bilateral netting with
multilateral netting: Start with the bilateral amounts.
$25 $10
$15$20
$10
$10
502/18/2016

U.K. affiliate owes the German affiliate $10; the
German affiliate owes U.S. $10.
$15 $10
$15$20
$10
$10
$10
512/18/2016

Thus, the U.K. affiliate nets its payment to the U.S. of
$10.
$15 $10
$15$20
$10
$10
522/18/2016

U.K. net payment of $10 to U.S. is combined with the
$20 it owes.
$15 $10
$15$20
$10
$10
532/18/2016

U.K. affiliates owes $30 to U.S.
$15 $10
$15$30
$10
542/18/2016

Consider Canadian and German affiliates.
$15 $10
$15$30
$10
552/18/2016

Canadian affiliate owes German affiliate $15 and the
German affiliate owes the U.S. $15.
$15 $10
$15$30
$10
562/18/2016

Canadian affiliate nets its payment to the U.S. of $15;
total Canadian affiliate payment to U.S. $25.
$10
$15
$30
$10
572/18/2016

Consider Canadian and U.K. affiliate
$10
$15
$30
$10
582/18/2016

U.K. affiliate owes Canadian affiliate $10; Canadian
affiliate owes U.S. $10.
$10
$15
$30
$10
592/18/2016

U.K. affiliate nets its payment to the U.S. of $10.
$10
$15
$30
602/18/2016

Combine this $10 with the $30 the U.K. affiliate owes
the U.S.
$10
$15
$30
612/18/2016

U.K. affiliate owes the U.S. $40.
$15
$40
622/18/2016

Total funds to be moved under multilateral netting is
$55.
$15
$40
632/18/2016

SUMMARY OF NETTING
Compare this (before netting).
$10 $35 $40$30
$20
$25
$60
$40
$10
$30
$20
$30
642/18/2016

BILATERAL NETTING
To this.
Bilateral Netting: Total funds moved = $90
$25 $10
$15$20
$10
$10
652/18/2016

 Decrease in the expenses associated with moving funds internationally
 Decrease in the number of foreign exchange transactions (also reduces costs)
 Reduction in intra-company float (wire transfers can take up to 5 days)
Financial rewards
 Favorable foreign exchange rates due to consolidation of several smaller payments to one
large payment
 Reduces administration cost
Control advantages
 Forces tighter control over information on transaction between subsidiaries
 Reduces time spent on administration & simplifies the reconciliation process
Benefits of Netting
662/18/2016

 Cash in excess of operating requirement may be held for
two reasons
 To meet fluctuations in working capital
 As a buffer to meet unpredictable financial needs
 Selecting Investment Opportunity
 Safety
 Maturity
 Marketability
Investing Surplus cash
672/18/2016

INVESTING OF SURPLUS CASH
Instruments Safety Maturity
Treasury Bills Safe 91 days & 364 days
Commercial Papers Risky
Min 7 days & Max 1
year from date of issue
Certificates of
Deposits
Safe 7 days to 1 year
Bank Deposits Safe Min 14 days
Inter-corporate
deposits
Risky Min 1 day, Max 1 year
Money market
mutual funds
Risky 15 days
682/18/2016

CORPORATE FINANCIAL
MANAGEMENT
69

CAPITAL DECISIONS
Financing
How much?
From
where/whom?
What cost?
When to
mobilize?
Investment
Where?
When?
How much?
702/18/2016

WORKING CAPITAL MANAGEMENT
• Working capital management is the management of the short-term investment and financing of
a company.
• Working capital management is to do with management of all aspects of both current assets
and current liabilities, so as to minimize the risk of insolvency while maximizing return on
assets
GOALS:
• Adequate cash flow for operations
• Most productive use of resources
• Satisfy maturing short term debt
2/18/2016 72

DETERMINANTS OF WORKING CAPITAL
• Nature of the business
• Sales and demand conditions
• Manufacturing policy
• Credit policy
• Availability of credit
• Operating efficiency
• Price level changes
• Growth and expansion plan
2/18/2016 73

CLASSIFICATION OF WORKING CAPITAL
• There are two possible interpretations of working capital concept
KINDS OF
WORKING CAPITAL
ON THE BASIS OF TIME
OPERATING CYCLE CONCEPT
ON THE BASIS OF CONCEPT
BALANCE SHEET CONCEPT
2/18/2016 74

BALANCE SHEET CONCEPT
• There are two interpretations of working capital under the balance sheet concept
BALANCE SHEET
CONCEPT
GROSS WORKING
CAPITAL
NET WORKING
CAPITAL
GROSS WORKING CAPITAL
= TOTAL CURRENT ASSETS
NET WORKING CAPITAL
= CURRENT ASSETS –
CURRENT LIABILITIES
2/18/2016 75

WORKING CAPITAL CYCLE
2/18/2016 76

OPERATING CYCLE
CONCEPT
REGULAR WORKING
CAPITAL
PERMANENT OR
FIXED WORKING
CAPITAL
TEMPORARY OR
VARIABLE WORKING
CAPITAL
SPECIAL WORKING
CAPITAL
SEASONAL WORKING
CAPITAL
RESERVE WORKING
CAPITAL
2/18/2016 77

PERMANENT WORKING CAPITAL
It is the minimum level of current assets that the firm maintains
Permanent Working Capital can be further divided into:
 Regular working capital:
It is the minimum amount of liquid capital required to keep up the circulation of the capital from cash
to inventories to receivables and back again to cash.
 Reserve margin or cushion working capital:
It is extra capital required to meet unforeseen contingencies that may arise in future.
782/18/2016

TEMPORARY OR VARIABLE WORKING CAPITAL
It is the extra working capital required to support the changing production and
sales activities of the firm
Variable Working Capital can be further divided into:
 Seasonal working capital:
It refers to liquid capital needed during the particular season.
 Special working capital:
It is that part of the variable capital which is needed for financing special operations
2/18/2016 79

DIFFERENCE BETWEEN PERMANENT & TEMPORARY WORKING
CAPITAL
Amount Variable Working Capital
of
Working
Capital
Permanent Working Capital
Time
2/18/2016 80

Variable Working Capital
Amount
of
Working
Capital
Permanent Working Capital
Time
2/18/2016 81

DANGERS OF INSUFFICIENT WORKING CAPITAL
 Full utilization of fixed assets is not possible
 Difficulty in the Maintenance of Machinery
 Decrease in Credit Rating
 Non utilization of favourable opportunities
 Decrease in Sales
 Difficulty in distribution of dividends
822/18/2016

DANGERS OF EXCESSIVE WORKING CAPITAL
 Excessive Inventory
 Excessive Debtors (liberal Credit policy)
 Adverse effect on profitability
832/18/2016

FINANCING WORKING CAPITAL
 Long Term Financing
 Short Term Financing
842/18/2016

APPROACHES TO DETERMINE AN APPROPRIATE
FINANCING-MIX
 The Matching approach
 Conservative approach
 Aggressive approach
852/18/2016

FINANCING NEEDS OVER TIME
Fixed Assets
Permanent Current Assets
Total Assets
Fluctuating Current Assets
Time
$
2/18/2016 87

MATCHING APPROACH TO ASSET
FINANCING
Fixed Assets
Total Assets
Time
$
Short-term
Debt
Long-term
Debt +
Equity
Capital
2/18/2016 88

CONSERVATIVE APPROACH TO ASSET
FINANCING
Fixed Assets
Total Assets
Time
$
Short-term
Debt
Long-term
Debt +
Equity
capital
2/18/2016 89

AGGRESSIVE APPROACH TO ASSET FINANCING
Fixed Assets
Total Assets
Time
$
Short-term
Debt
Long-term
Debt +
Equity
capital
2/18/2016 90

RELATIVE PROPORTION OF LONG TERM AND SHORT
TERM DEBT
2/18/2016 91

COMPARING THE THREE STRATEGIES OF WORKING
CAPITAL FINANCING
FACTORS CONSERVATIVE AGRESSIVE MATCHING
LIQUIDITY HIGH LOW BALANCED
PROFITABILITY LOW HIGH BALANCED
RISK LOW HIGH BALANCED
ASSET UTILIZATION LOW HIGH MODERATE
WORKING CAPITAL HIGH LOW MODERATE
2/18/2016 92

WHAT IS RISK?
 Risk is the potential that a chosen action or activity (including the
choice of inaction) will lead to a loss (an undesirable outcome)
 Damodaran says, risk includes not only "downside risk” but also
"upside risk" (returns that exceed expectations)
942/18/2016

CORPORATE RISKS
• Business
Risks-
 Sales
 Marketing
 Manufacturing
 Competition
 Reputation
• Market Risks
 Foreign
Exchange
 Interest Rates
 Commodity
 Equity
 Inflation
Liquidity Risks
 Funding Risks
 Long Term v/s
Short Term
 Capital
Credit Risks
 Commercial
 Counterparty
 Settlement
Operational Risks
 Systems
 Controls
 Regulatory
 Frauds
 Weather
 Natural disasters
2/18/2016 95

Definition
It is the identification, assessment, and prioritization of risk
followed by coordinated and economical application of
resources to minimize, monitor, and control the probability
and/or impact of unfortunate events or to maximize the
realization of opportunities.
Risk Management
962/18/2016

97
How To Manage Risk?
2/18/2016

98
Risk Management Techniques
Avoidance
Loss Prevention
Loss Reduction
Seperation
Diversification
Risk
Control Transfer
Insurance
Hedging
Retention
Risk
Financing
2/18/2016

HEDGING
Hedging is the act of reducing your risk of losing money in the future.
992/18/2016

BENEFITS OF HEDGING
 Hedging as a strategic resource
 Capital raising capability
 Lowering distress costs
 Lowering tax liabilities
 Hedging as a tool for corporate governance
1002/18/2016

HEDGING STRATEGIES/ INSTRUMENTS
 Forwards
 Futures
 Options
 Swaps
1012/18/2016

FOREIGN EXCHANGE EXPOSURE RISK
Transaction Translation
Economic
1032/18/2016

TRANSACTION EXPOSURE
 ∆ in FE rate ∆ in outstanding obligations
 Hits the P&L a/c, profitability takes a hit
Initiate the
deal
Negotiation
Modifying or
accepting the
deal
Final
delivery
date
1042/18/2016

 The Net Positive Transaction Exposure indicates strengthening of the
domestic currency against the foreign currency and depreciation of
the foreign currency makes it profitable.
 The Net Negative Transaction Exposure indicates strengthening of
domestic currency against the foreign currency and appreciating of
the foreign currency makes it profitable.
1062/18/2016

STRATEGIES FOR TRANSACTION EXPOSURE
 Hedging
 Currency invoicing
 Exposure netting
 Leading & lagging
1072/18/2016

EXAMPLE ON HEDGING
1082/18/2016

LEADING & LAGGING
 Indian Manufacture has today $1million for import material and to
receive $1million from export order
 1USD = 60 INR
Expecting rupee to appreciate (eg
59)
Expecting rupee to depreciate(eg 61)
Payments – delay the payment (lagging) Payments- prompt payments (leading)
Receipts-immediate receipt (leading) Reciepts- delay the receipt (lagging)
1102/18/2016

EXPOSURE NETTING
XYZ CO.
(CANADA)
US
SUPPLIER
A CO.
(Europe)
B CO.
Pay $10million
Receive
Euro
5million
Receive
1million
CHF
The company’s net currency exposure is USD 2.15 million (i.e. USD 10
million – [(5 x 1.35) + (1 x 1.10)]
1112/18/2016

TRANSLATION EXPOSURE
Four Methods to translate foreign currency to home currency:
 Current/Non-Current Method: All current assets and current liabilities are translated
at current exchange rate
 Monetary/ Non-Monetary Method: All monetary assets and liabilities are translated
at current exchange rate
 Temporal Method: Same as Monetary/Non-Monetary method BUT inventory may be
translated at current exchange rate IF it is shown at market value
 Current Rate Method: All balance sheet and income statement items are translated at
current exchange rate
1122/18/2016

TATA UK (Parent company) has a subsidiary in US
Tata invests $5,00,000 in its subsidiary in US (USD/EUR=1)
On the year end closing date the $ (USD/EUR=2)
Instead of 5,00,000 euros only 2,50,000 euros are translated (5,00,000/2)
EXAMPLE
1132/18/2016

ECONOMIC EXPOSURE
 Unexpected currency fluctuations on a company’s future cash flows and
market value
 Long term in nature
 Substantial Impact
 Difficult to quantify
1142/18/2016

Cash Flow of A = - Fixed – Float + Fixed
Cash Flow of B = - Float – Fixed + Float
116
Bank
BA
Bank
Fixed
Float
Float
Fixed
2/18/2016

CASE STUDY
• Oil refinery XYZ ltd needs 1,00,000 barrels of crude oil in 3 months.
• Current market price is $44.20/barrel
• Crude oil futures $44.00/barrel
100 contracts of 1000 each: 100 x 1000
=1,00,000 barrels
Total cost =$44,00,000
1182/18/2016

SCENARIO #1: CRUDE OIL SPOT PRICE ROSE BY
10% TO USD 48.62/BARREL ON DELIVERY DATE
1192/18/2016

SCENARIO #2: CRUDE OIL SPOT PRICE FELL BY 10% TO USD
39.78/BARREL ON DELIVERY DATE
1202/18/2016

treasury management in corporates

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treasury management in corporates