Long-term strategic success depends on good management of short-term operational capital – centralised cash management and balanced investment are vital, says ABN AMRO’s Ann Cairns.

How should global corporations best manage short-term operational capital needs to mesh with long-term strategic aims? Long-term objectives are invariably dependent on performance over the shorter term. A glance at recent corporate history shows that good management of short-term operational capital has often been the survival factor for companies facing trading or event-driven difficulties. So, where the corporation’s day-to-day working capital is concerned, preservation of value will always be the treasurer’s primary motivation.

Liquidity is also key. Accurate cash flow forecasting is still a considerable challenge for companies. Studies by research firm BDRC, carried out on behalf of ABN AMRO’s Working Capital business, reveal that treasurers’ ability to predict cash balances falls steeply for time horizons beyond two-to-three days. So keeping short-termfunds highly liquid is obviously critical (see graph).

Once these two requirements are satisfied, treasurers will also be looking for return, operational efficiency and transparency. Transparency and control concerns are moving up the treasurer’s agenda in response to increasing corporate governance requirements. For example, group treasurers are now pushing for control and visibility not only of the balances they manage themselves, but of local accounts, account opening procedures and local investment policies.

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The centralisation route

Working with a regional banking partner to centralise operating balances and investments at a regional treasury level provides the best opportunity to satisfy these multiple objectives.

To facilitate control and visibility of group flows, one solution is to sweep balances to a central treasury account on a daily basis (this will not be onerous if automated cross-border sweeps, multi-bank cash concentration draw-downs, and zero-balancing can be used).

Centralising cash in this way will also allow self-funding to be maximised, since positive balances in one part of the business will be recognised as available to cover shortfalls elsewhere. Optimising interest across funds in separate accounts with one bank (using notional pooling techniques) may also be a valuable option in some situations. And creating a larger pool of funds at regional level for investment will increase the opportunity to get the best return. The portfolio effect created will also moderate volatility of the funds. Finally, banking and investment costs will be better controlled if managed centrally.

While such a structure is ideal, creating the structure that best fits the corporation requires careful analysis. Many factors must be taken into account, including: the structure of the organisation, specific business needs in particular markets, the number ofcurrencies and the amounts of each involved, tax and regulatory controls in the various jurisdictions where the company operates (and cross-border) and the need to match the geographic footprint of regional banking partners with that of the corporation.

Review brings rewards

But as markets liberalise and banks continue to develop their capabilities, constant review of the opportunities to get the scale, control and efficiency benefits of operating cash centralisation will be rewarded. To give just a few examples:

  • Multi-bank cash concentration services automate the process of transferring cash surpluses from accounts with multiple banks to a single “concentration” bank. This partner bank model is proving effective for companies wanting to bring liquidity in EU accession countries into European regional structures.
  • Companies with US dollars in Europe are now benefiting from automated daily zero-balancing, allowing them to centralise dollars in the region in the same way that they do euros.
  • In Asia, while financial markets, regulations and banking infrastructure are still evolving in many countries, international banks are drawing on their global expertise to structure innovative solutions. For example, in China, corporations can concentrate their surpluses and cover deficit positions across multiple entities using a multi-party entrust loan arrangement (an inter-company loan structure which can be enhanced to achieve the benefits of cash pooling within China).
  • In Latin America, the defined key objectives may best be served by holding surpluses in regional pooling locations such as Curacao for use in inter-company funding.

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Balanced investment choices

The investment choices for short-term cash managers will always involve a careful balancing of the defined objectives: risk, liquidity, return, efficiency and control. For the shortest term, daily operating funds, most companies’ investment policies allow only the narrowest room for manoeuvre with regard to risk so, in this case, the treasurer’s skill will largely be exercised in getting the best of liquidity, return and operational efficiency.

Given the expanding role and focus of the corporate treasurer to reduce operational costs, demand is strong for less resource-intensive alternative investment options for this cash (without sacrificing anything in terms of liquidity or return). The BDRC/ABN AMRO research shows that European treasurers are heavy users of deposits. On average, one in six treasurers makes up to 20 investments a month in one-to-three month term deposits, requiring active pricing, monitoring and multiple transactions. While this is certainly a valid option, alternatives are available that can offer higher degrees of operational efficiency.

Triple-A rated money market funds are an increasingly popular choice in this scenario, combining the potential to enhance returns (through diversified investment in high-rated instruments) with the efficiency of late cut-off times, daily investment and liquidity and automatic rollover. Automatic daily sweeps of pre-determined cash balances from current accounts to money market funds add more efficiency to the investment process.

Alternatively, where a large pool of cash is available but may be needed at short notice, a corporate investment account may provide a higher return, with the same liquidity and convenience factors. Differentiation of operating and investment balances can be achieved with a structured, high yield current account, with tiered interest levels and immediate availability of funds.

Where short-term funds are available for slightly longer time horizons (so-called core liquidity), other options come into play. The diversifying market of money funds now includes interest growth funds. With a rating of double-A, these funds are convenient to use and aim to provide capital preservation but with enhanced returns and slightly less liquidity. Alternatively, it may be preferable to tailor longer-term cash management options, with liquidity components built in, to provide the optimal balance of needs.

Ultimately, managing short-term, operational capital involves a balance of risk and efficiency to ensure day-to-day financial resilience for the corporation, as the basis for longer-term strategic success. Centralised cash management and investment is core to achieving this.

Ann Cairns is managing director of working capital at ABN AMRO

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