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Friday, 24th May 2024
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The changing face of cash management – from cash investment to portfolio management Back  
The concept of cash management for corporate treasurers has changed significantly in recent years, writes Pat Leavy. Traditionally, corporates saw cash management in terms of surplus cash investment and its main components such as security and liquidity, and the concept of 'portfolio' management related to the construction of investment portfolios. Now however, corporates consider the total cash value chain as the new 'portfolio' and are challenged to maximise value for the company from each element of this chain. In addition, there has also been a strategic shift in the status of cash management within companies, driven by legislation such as Sarbanes Oxley, and it is now high up on the corporate management agenda securing senior management and board attention.
It may seem somewhat patronising to commence an article in FINANCE magazine with trying to define what cash management is, but the reality is that it means different things to different people, and the corporate view of it has changed significantly in recent years.

Traditionally, corporates saw cash management in terms of surplus cash investment and its main components – security, liquidity, risk, return, product types, portfolio management. Traditionally, the concept of ‘portfolio’ management related to the construction of investment portfolios. Now however, corporates consider the total cash value chain as the new ‘portfolio’ and are challenged to maximise value for the company from each element of this chain. This is an ‘Enterprise’ approach to cash management and aligns with the concept of enterprise risk management, which in itself is evolving.

There are three components to the cash value chain – core cash management, supply chain management and demand based management. Core cash management involves banking and bank relationships; bank accounts and structures including cash concentration and pooling; electronic banking, balance reporting, payment initiation and systems interfacing; cash positioning and cash flow forecasting; cash investments and strategy; the organisational and infrastructural arrangements to effectively support cash management in multi jurisdictional environments.

Supply-chain management includes work-in-progress and finished goods, supply and distribution, and procurement. The traditional view of demand based management (DBM) focuses on debtors and credit management. DBM now seeks to co-ordinate customer requirements with planning and scheduling, essentially linking and relating the selling side of the cycle to the supply-chain.
This means that strategic cash management and the concept of portfolio management for corporates has expanded in all directions so that it encompasses the impact of cash on the company in its entirety.

It is worth noting that there has also been a strategic shift in the status of cash management within companies, where it is now high up on the corporate management agenda securing senior management and board attention. This focus is driven by the obligations in relation to corporate governance, legislation such as Sarbanes Oxley in the US, and accounting and regulatory requirements such as IAS39, FAS 133 and Basle II. Cash is now a hot topic and we see many corporates investing heavily to ensure that key objectives, such as control, visibility, access, security and liquidity, are met. Companies are not in a position to takes risk in the management of its corporate cash asset.

Cash levels
Most of the items mentioned above are to do with maxmising the efficiency of cash. However, once that is put in place and operational, a key strategic issue is whether there is an optimal level of cash for a company? Obviously, the underlying business nature of a company determines if it generates or consumes cash, the extent of its liquidity gap and indeed the relationship between liquidity needs and the availability of surplus cash.

Lenders dictate and often investor analysts influence benchmarks around minimum cash levels. These are easily recognised in loan agreements where the focus of financial covenants is now very much on cash based ratios, for example minimum free cash flow cover and the effective replacement of PBIT (profit before interest and tax) with EBITDA (earnings before interest, taxes, depreciation and amortization).

There is a comfort with having surplus cash, but is there a problem with too much cash? For some companies there can be a strategic dimension to holding significant cash amounts to underpin the business and to provide investors with the level of comfort deemed necessary for that business. Apart from these types of situations, a comfortable level of cash can be determined by aligning the cash level to the company’s maximum cumulative capital requirement (being the cumulative investment in plant, machinery, working capital, etc.). But what about levels of cash beyond that comfort level? This cash is often held in investment instruments and securities. Portfolio theory would have it that investments of this nature are a zero-NPV investment. This concept forces companies to seek higher returns through new commercial activities. Companies that have been unsuccessful in achieving this over the longer term have looked to increased dividend payouts, share buy-backs and indeed some companies have been consumed and taken over by others.

The cash market
The size of the cash market is enormous – external trade for Ireland in 2004 amounted to €83.4 billion in exports and €50 billion in imports. This compares to UK monthly exports for June 2005 of ?116 billion and imports of ?115 billion; money supply (broad definition) in Ireland in December 2004 amounted to €128 billion. We could go on, but this illustrates the significance of the cash market that requires products and service to meet corporate cash management needs.
The trend in product development in recent years has been technology driven. Automation and STP of treasury processes is seen by corporates as a means to improve control.

One of the most significant changes in technology has been the move towards online banking. Electronic banking systems, which is the core cash management ‘tool’ for many corporates, has migrated from a PC based application to a web enabled one. At one level, some financial institutions have developed and invested heavily in sophisticated internet EB systems with broad functionality and capability, including the ability to interface with a wide variety of treasury management, ERP and accounting systems. Some institutions offer lower level online access to balance reporting and limited payment initiation capability. Others are currently in the development phase.

The supply and demand sides of cash value chain are also driving forward with new products that are technology based. Electronic auctions provide online ability to set up and respond to tenders and contract negotiations. Electronic procurement provides the ability to trade with chosen suppliers online. Electronic invoicing offers guaranteed delivery of invoices directly to suppliers and for the recipient, invoice data can be received directly into accounting systems. Electronic documentation management, electronic trade finance are just some of the other products available. These are all aimed at improving the cash value chain through cost and time savings, and also improving control.

At the investment end of the chain, on-line trading systems, automatic sweeping into investment or money market funds are available. For portfolio management, sophisticated systems, including our own system, FTI STAR, are available to go beyond transaction processing, and concentrate on analyses such as portfolio and scenario analysis, reporting, decision making and strategic portfolio structuring.

Although many companies are slow to embrace the full impact of technology due to short term budgetary constraints, it is clear that, over time, the full cash management value chain will be serviced by an integrated set of technology based products and solutions, aimed at meeting corporate treasury management operational and strategic needs.

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