Treasury Professional Duties
• Maintain liquidity. Liquidity is defined as the organization’s ability to pay its bills out of cash accounts or other assets that can quickly be turned into cash. Liquidity ensures that the organization is able to meet current and future financial obligations in a timely and cost- effective manner.
• Optimize cash resources. The treasury function uses policies, procedures and
strategies that minimize holdings of non-interest-earning cash balances while also
providing adequate cash to ensure liquidity. Excess cash balances are invested to
generate interest income or pay down debt and reduce interest expenses. Money market
accounts are often used to maintain liquidity while generating interest.
To optimize cash resources, treasury professionals work to speed up cash inflows,
control cash outflows and minimize the net cost of the process. To minimize the net
cost of optimizing cash, cash concentration or pooling is used.
Cash inflows rarely equal cash outflows on a particular day. Cash concentration or cash
pooling is the process of holding cash in a special bank account from which outflows are
paid. When the concentration account falls below a predetermined balance, short-term
investments are liquidated and/or funds are borrowed. When there are excess funds in
the concentration account, short-term investments are purchased or debt is paid down.
To manage concentration accounts and to optimize cash resources, treasury
professionals create cash forecasts. These forecasts help manage activities such as
scheduling cash concentration account transfers, funding disbursement accounts and
making short-term investing and borrowing decisions. Cash forecasts require a treasury
professional to take three steps:
• Estimate future cash inflows and outflows.
• Generate a pro forma cash position.
• Identify how to cover any cash deficits and use any cash surpluses.
In addition to managing liquidity, treasury professionals also:
Other Treasury Professional Duties
• Manage risk. The treasury function identifies, measures, analyzes and mitigates the organization’s exposure to many types of risk (e.g., interest rate, foreign exchange [FX],
counterparty, operational, etc.).
• Maintain access to and minimize cost of short-term financing. Treasury
establishes and maintains reliable access to short-term borrowing facilities at the lowest
possible cost. Treasury management uses short-term borrowing facilities to finance any
working capital gap that may occur when the operating cycle produces cash outflows
that precede cash inflows.
Short-Term Financing
To meet short-term financing needs—those that span less than the operating cycle or
less than a year or two—treasury management has a number of tools at their disposal.
• Credit lines/revolving credit. Organizations arrange these accounts with banks in
order to have funds available on short notice. These are often used when there is a
shortage of cash for a very short period of time such as the working capital gaps
discussed earlier.
• Short-term commercial loans. Sometimes organizations issue their own
short-term debt directly to investors rather than going to a bank for the loan. In
general, when a bank makes a loan, they are actually consolidating the funds of
various investors to be used for loans. In the case of commercial loans, or
commercial paper as it is sometimes called, large organizations can bypass the bank
and solicit loans directly from investors.
There are other short-term strategies for acquiring immediate funds, such as
factoring accounts receivable through a commercial lender. In this strategy, a
percentage of the accounts receivable balance is received as a cash advance from a
lender, with repayment terms including the principal, commissions and other
charges.
The treasury function holds the majority of the responsibility for the short-term funding of
the organization. Professionals in charge of long-term financial management, which may be treasury or other FP&A professionals, work to maintain access to medium- and
long-term financing to support investments in capital assets. This includes support for
planned asset expansion as well as for the firm’s existing asset base. Medium- and
long-term financing provide the financial flexibility necessary to exert strategic action
when investment opportunities arise.
Medium- and Long-Term Financing
The funding needs of the organization that extend beyond the operating cycle are
met with medium- or long-term financing. This financing can take the form of equity
or debt. Equity results from the sale of shares of common or preferred stock, while
debt can come in many different forms: bank loans, long-term lease arrangements
or the issuance of bonds.
Stocks and bonds are traded on structured markets called capital markets. The New York
Stock Exchange is an example of a capital market. Organizations can obtain financing by
issuing stocks or bonds that are traded on one of these markets. The purchasers of the
bonds pay for the right to receive interest on the bond and the repayment of the bond at
maturity. The purchasers of the stocks pay for the right to receive a portion of the
organization’s future profits or cash flow. Stock sold to investors is considered part of the
organization’s equity.
Organizations can also obtain long-term funding through long-term debt and lease
arrangements. There are many things to consider in obtaining long-term debt, including
the amount of the loan, the interest to be paid, the term of the loan and debt covenants
imposed by the lender
Under long-term lease agreements, rather than purchasing property outright, the
organization agrees to ongoing lease payments. Leases can be used to acquire not
only land and buildings but also other depreciable assets such as equipment.
A third source of financing for an organization is the reinvestment of excess cash flows
earned. This is called retained earnings and is part of an organization’s equity. Equity
therefore includes the stocks sold to investors and earnings that have been retained in
the company for future use.
In corporations, the tax implications of using debt financing versus equity financing must
also be considered. Debt is usually a less-expensive capital source due to the
deductibility of interest payments, but too much debt may increase the risk of financial
distress to the firm due to the imposition of interest and principal payments. The mixture
of equity versus debt for funding an organization is called its capital structure. Most
organizations will establish a target capital structure that provides the desired mix of
different capital sources and, ideally, the minimum overall cost of funds while preserving
an acceptable degree of financial flexibility. The corporate finance function typically
provides input on the capital structure and reinvesting of cash flows. It also oversees the
activities of issuing stocks and bonds and obtaining long- and short-term debt and
leases.
Application to FP&A Professionals
Responsibility for financing decisions is held by different functional groups in different
organizations, but FP&A professionals are closely involved in the process. While the
treasury personnel have primary responsibility for short-term cash needs, the FP&A
professional may still provide input into the decisions. In addition, the FP&A professional
can substantially contribute to, if not hold responsibility for, long-term financing decisions.
The FP&A professional must understand the organization’s business cycle and may work
with treasury to forecast cash needs based on operations and outstanding obligations.
FP&A must be able to identify business risks and help treasury translate the risks into
financial and cash flow risks. FP&A professionals contribute financial forecasts related to
strategic plans in order to anticipate long-term financing needs. They must be able to
evaluate which financing options are best to meet the long-term financing needs. In
addition, the FP&A professionals perform scenario analysis to improve cash and other
forecasts to minimize the amount of financing needed
It is generally agreed that financing decisions cannot make an organization successful
but poor financing decisions can undermine and seriously disrupt the success of an
organization. How the funds obtained through financing are used (invested) is more
likely to determine the overall financial success of an organization. Investing decisions are another finance activity and will be discussed next.
Investing
Investing decisions are focused on how the assets acquired through financing
decisions and through the operations of the organization are used. Again, the focus
is on maximizing the efficient use of resources with a goal of investing in assets
that generate a return exceeding the cost of the funds invested. Investment
decisions are often referred to as capital expenditures or capital budgeting.
Organizations need to make major investments in tangible items such as land,
buildings and machinery. But they also need to invest in intangible items such as
research and development, marketing and selling. At the same time, excess cash
flows must earn the highest rate of return possible. All of these decisions enter into
the financial management activity of investing.
Because organizations have limited financial resources, it is important to assess
carefully which competing projects, initiatives or acquisitions to fund and how much to
invest in each competing option. This analysis involves estimating both the risks and
returns of a given project. The outcome of this analysis could also suggest the divesting
of some asset. For example, a school district may decide that some schools need to be
closed in order to meet budget constraints. In a corporation, it may involve the sale of a
division or subsidiary or discontinuing a product line because the company’s capital
resources could be used more effectively elsewhere. An organization accumulates
assets through financing decisions and through excess cash flows from their operations.
Treasury Professional Duties
The assets are generally invested in one of three categories:
• Working capital. Working capital is defined as the current assets used to operate
the business less the current liabilities assumed to acquire them. Working capital is
made up of things like the raw materials for production or resale and other direct
production costs. Investing in working capital is part of the ongoing cost of business
• Operating expenditures. These expenditures are operating costs such as salaries,
utilities, etc. As with working capital, investing in operating expenditures is part of the
ongoing cost of business.
• Capital expenditures. These are expenditures for assets that will provide benefits
over the long term. The resulting assets from these expenditures are depreciated or
amortized over the life of the asset. Examples of capital expenditures are buildings,
equipment, improvements to property or buildings and the purchase of another
business.
Investment Decisions and Analysis
Investment decisions between alternative capital expenditures are where the FP&A
professional contributes to the process. Investment in ongoing working capital and
operating expenditures must occur to keep the organization operating. But the
investment in capital expenditures may include many options and requires significant
analysis. This is generally performed by the FP&A professional.
The first part of the analysis requires a quantitative evaluation of the alternative projects
in which an organization might invest capital resources. Quantitative factors include
costs, expected benefits and potential cash flows.
Next an estimate of the economic returns of projects in relation to one another as well
as to the organization’s cost of capital must be completed.
Finally, the qualitative factors of projects must be evaluated. Qualitative factors include
considerations such as how a project fits into an organization’s core strategy. In a
for-profit entity, there may also be a consideration about whether it is an activity in
which a company has or can gain a competitive advantage.
Investing: Application to FP&A Professionals
Investing decisions are a key FP&A professional contribution to an organization.
As noted earlier, financing decisions tend not to drive the fundamental success of
an organization but investing decisions do. How efficiently available assets are
used to produce returns determines the financial success of the organization and
to what extent the financial management goal of maximizing shareholder wealth is
met.
FP&A professionals are usually significantly involved in budgeting and forecasting. Along
with ongoing budgeting and forecasting analysis, the FP&A professional is often called to
contribute analysis on major one-time investment decisions such as purchasing another
business or investing in a new facility. To provide a complete analysis, the FP&A
professional must gather all input, both financial and non-financial, analyze costs versus
benefits, consider the timing, advisability and best options for taking on debt, research
competition and market and technology trends, and consider the quality and strength of
the management team.
Dividend Payout Policy
The result of the financing and investing decisions made by an organization is the firm’s
net income (profit or loss). In theory, the organization’s maximum dividend is its net
income (unless it borrows or uses other sources of funds to pay a dividend). However,
paying all of net income as a dividend would not leave any money available to fund future
growth and would create unstable dividends in each period, which is highly undesirable.
Dividend policy is typically set based on a number of factors:
• The sustainable level of cash a company generates
• The investment needs for the foreseeable future
• Business volatility
• Financing
• Required cash surplus
Generally dividend payout is the last use of cash after these other factors have been
considered. Payout policy also considers tax rates on ordinary income and capital
gains. Therefore, funds available to pay dividends could be either net income or net
cash flow less funds that are necessary to reinvest in the organization.
The corporate finance function assesses payout policy alternatives and advises senior
management and the board of directors. The alternatives include to retain all the net
income for future use or to distribute some or all of it to shareholders and, if so, how
much to distribute and how to distribute it.
The payout decision has three options for net income for a period:
• Issue dividends. Some portion of the profit or excess cash flow can be paid out to
shareholders as dividends. Dividends provide shareholders with a return on their
investment.
• Repurchase outstanding shares. Some portion of the profit or excess cash flow can
be used to repurchase outstanding shares. This reduces the number of shares
outstanding and thereby increases the value per share. In this way, shareholders
receive a return on their investment.
• Retain the earnings. If it is determined that long-term or short-term needs require it,
excess earnings can be held and reinvested in the organization. These earnings are
reflected in retained earnings and comprise part of the value of the shares held by
shareholders. Therefore, in general, the change in retained earnings (the change from
the prior period to the next period) on the balance sheet is equal to net income minus
dividends and/or share repurchases.
If the assumptions are that the organization will neither borrow funds to pay the dividend
nor pay more than the amount of cash available after considering necessary investments
in the organization’s growth, then other ways to measure funds available for dividends
are to use free cash flow (FCF) or free cash flow to equity (FCFE).
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