Iowa How Does Treasury Measure Success.ppt...Financial Risk Analysis 4% Investment and Counterparty...

How Does Treasury MeasureIts Success?

A Presentation to Iowa AFP February 12, 2015

by



Bruce C. Lynn, CTPManaging Partner

2/15/2015 © The Financial Executives Consulting Group LLC 1

Agenda

The year ahead and what to watch for Why treasury has been unsuccessful to date in defining “success” What a starter set of success measures could look like in 2015 Company change needed to measure success How Treasury can build a business case for changeConclusions / Actions Steps


The Year AheadBusiness environment still not perfect• US economy still not back to “normal” • Global markets are cautious• New sheriff in town: SEC, Basel III, etcProfitability (“how much”) maybe key, but investors are asking “when”:• How much liquidity is “enough” for best use?• How much risk is “too much” to get returns ?• What are counterparties thinking?It is all about risk = exposure to an uncertain future creates (wait for it)…uncertainty , placing a premium on liquidity


The Year Behind - BorrowingBanks continue to lend…to those who qualify

“Tightening Standards” implies :• More restrictive covenants • Lower loan limits• Shorter maturities

• Higher loan spreads• More collateral

Source: Federal Reserve Senior Loan Officer Opinion Survey on Bank Lending Practices – Sept 2014

Credit stds unlikely to loosen more


The Year Behind - LiquidityS& P 500 Non Finacial Companies (430 co.)

Results as of 9/30/14

-200

0

200

400

600

800

1,000

01 -

Basic

Mat

erial

s02

- Cap

ital G

oods

03 -

Conglo

mer

ates

04 -

Consu

mer

Cyc

lical

05 -

Consu

mer

Non

-Cyc

lica

06 -

Ener

gy08

- Hea

lth C

are

09 -

Serv

ices

10 -

Tech

nolog

y11

- Tr

ansp

ortat

ion

12 -

Utilitie

s

$ in

Bill

ions

Cash & S/T Equiv. L/T + S/T Debt Free Cash Flow 12 mnths

Cash levels, Debt access, Free cash flow not all equal

by industry


The Year Behind – Best Uses for Cash?

Investors will be seeking higher payout %?


The Years Behind - RatesLast Upward Trend for Interest Rates: 2005

“Normal” could be > 10X today’s rate


The Year Behind – L/T Rates

“Normal” could be > 50% above today’s rate


The Year Ahead – Good News?

Growth Trend up: only took 2X as long


The Year Ahead - Rates

*Forecasts of 17 Federal Open Market Committee (FOMC) participants, midpoints of central tendency except for federal funds rate which is a median estimate.

Rates are Rising – Expect your Interest Expense to Follow


The Year Ahead – One ScenarioA near term scenario• Competitors actions remain uncertain • Higher interest rates in 2015• Stronger USD: Exports more expensive; Fgn

income worth less; lower Fgn investment costs• Investors want cash to cash returns “now”• Enough liquidity?

More payouts = less cash remains for operations, debt repay, future investmentsBanks remain reluctant lendors (Basel LCR? RAROC)

• Debt capacity maxed out?• Rely on organic growth or use cash for M & A?Is treasury equipped for this scenario?If so, what is a “successful” outcome ?


The Year Ahead - Worries?

Source: AFP – 2015 AFP Business Outlook Survey, Nov 2014

Missing: Counterparty concerns? Best use of

Cash?


Treasury PrioritiesThe Role of Treasury (Top 10 of 20)

% Distribution of Responsibility within Organization 2014 2011

Bank Relationship Mgt 94 94

Borrowing: Short Term 86 89

Borrowing: Long Term 85 81

Investing Short Term 77 86

Investing: Long Terrm 62 74

Risk Mgt: Financial 53 44

Counterparty Risk Analysis 50 51

Working Capital Management 49 32

Insurance 47 39

46 N/A

Global Treasury Mgt ? 88

Cash Flow Forecasting ? 79

Sources: AFP 2011 Strategic Role of Treasury Survey (673 responses); 2014 Survey (243 responses; 55% Sales > 1Bn)

Act as Financial Consultant


Treasury Priorities

Source: PWC Global Treasury Survey, Oct. 2014. 110 Responses; 70% Sales > 3Bn

Different surveySimilar results

High Priorities1. Borrowing2. Cash Mgt3. Cash Flow

Note: Low Priorities• Cost Treasury Ops• Hedge A/C


RiskMgt

(Mkt, Credit, Ops)

Cash Accounting(focus on creating, posting, reconciling transactions)

DebtInvestment

Cash Management(focus on balances)

DebtInvestment

Cash Management(focus on balances)

Treasury Reality vs Its Priorities• Focused on internal processing

• Resources devoted to repetitive tasks

Cash

Tomorrow

Today


Treasury Priorities - ResourcesAllocation of Treasury Resources

(PWC Global Treasury Survey, Oct 2014,p5)

Cash Management21%

Maintenance of TMSs2%

Financial Risk Analysis4%

Investment and Counterparty Risk Mgt (Credit)

7%

Interest rate risk management (Mkt)7%

Commodity Risk Mgt (Mkt Risk)10%

Other Treasury Activities10% Finanicng & Bank Mgt

13%

FX Mgt12%

Back Office14%

45% resources on cash, back office, other.Too much processing?


Treasury Performance – Few Metrics

Measurement & Communication of Results to Executive Management & Board :

Treasury Contribution to Company Performance

AllRevenues

< 1BNRevenues

> 1Bn

No Measures / No Communication 51% 43%

Has Measures & Communicates 55% 49% 57%

Totals 100% 100% 100%

Source: AFP 2014 Strategic Role of Treasury Survey (243 responses)

45%


Treasury Metrics – From Businesses

Source: PWC Global Treasury Survey, Oct. 2014. 110 Responses; 70% Sales > 3Bn

Much data reported, little information?


Treasury Metrics – to Board

Results consistent with AFP Survey


Treasury Performance - TodayCompany uses profits not liquidity or risk to measure successFew treasuries successful because only some (55%) measure their success• Too much processing.. Not enough planning

Missing data about operational cash flows.Result: over borrowed, over invested, over exposed: which is it & when do you know?

• Problems are solved rather than prevented?Resources constrained by past results• “ERP system” consists of spreadsheets / emails

Treasury systems not priority for IT No integrated view of global cash flows

• Staff levels - “outgunned” by Controllers or other financial or operating units


A Framework for the Future

If You Do Not Know Where You are Going…

Any Road Will Take You There

Mr. Cheshire Cat

What Gets Measured Gets Managed…

Mr. Peter Drucker

Who To Trust?


Risk (Leverage)

Liquidity (Sources = Uses)

A Framework for the Future

Profitability(Income Growth/ROE)

Profitability(Income Growth/ROE)

Success Measures = Beat “the Market”

ROE = Profitability x Asset Turnover x Financial Leverage

Market Expectations

• Growth • Return

Mgt Expectations

• Growth • Return


Treasury Tomorrow

Cash Management

Risk Management

Debt Management

Investment Management

FinancialMarkets

&Institutions

Company&

OperatingUnits

• Policies Highly Visible• Interactive Communications• Plan, Actual & Forecast in Sync

• Functions & Systems integrated• Performance Metrics in Place to

Demonstrate Value


Treasury TomorrowProfitability metrics will remain popular because they drive bonuses. Examples:• EPS – key external market measure• Earnings growth – market and mgt measure• EBITDA (operating earnings). Weakness:

Capital is free (no interest, no dividends)No need for upfront cash (capex? R&D?)No gains /losses from change in mkt. ratesAfter tax income the same around the world

Link liquidity to obtain “real” profitability• Can’t settle / collect: Then it did not happen…• Bringing it home: Fgn cash vs US uses (Apple)


S & P Non Financial Companies (430 companies)Quarterly Trends as of 9/30/14

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

Q8 Q7 Q6 Q5 Q4 Q3 Q2 9/30/2014

$ in

Bill

ions

0

1

2

3

4

5

6

7

8

9

10

Rat

io: D

ebt /

Fre

e ca

sh fl

ow

Cash & S/T Equiv. Total Debt Leverage: Debt / free cash flow

Corporate ConcernsTreasury to CFO:

How much risk (debt / free cash flow) is “too much”?

Cash level trend up, but is debt still “too high”?


Corporate ConcernsTreasury to CFO:

Measuring how much cash is “enough”?

S & P Non Financial Companies (430 companies)Quarterly Trends as of 9/30/14

1,100

1,150

1,200

1,250

1,300

1,350

1,400

Q8 Q7 Q6 Q5 Q4 Q3 Q2 9/30/2014

$ in

Bill

ions

0

5

10

15

20

25

30

35

40

45

50

Rat

io: D

ebt /

Fre

e ca

sh fl

ow o

r Day

s

Cash & S/T Equiv. Leverage: Debt / free cash flow Cash Conversion (days) Days Cash on Hand (days)


Building the Business Case for ChangeFocusing on liquidity & leverage metrics• 9AM: Where in the world is my cash?• 11AM: Do I invest or do I borrow?• End of day : forecasting the “right” decision for tomorrow?

“Make or Buy”: balance sources with uses• Make: Cash on hand + Cash flows forecasted

If long cash: repay & borrow less / lower mkt exposure?If short: “Buy” in the market. Fixed or variable rate?

• Buy (External source): Invest sooner to become more competitive?Investors dividends = better stock price ?

Striking the “right” balance?• Requires integrating P, L, R goals for the future• Ability to measure actual results vs. tactical and strategic goals

The catch: need resources now (e.g. systems, staff, etc) to forecast future benefits


Building the Business Case for ChangeTo start: • Treasury should own the cash flow statement• Market prizes operational cash flows

Comply or die – Do NOT become MF GlobalCreate performance measures from 2 perspectives:• Top Down – link uses with sources by SBU• Bottom up – link sources and uses at transactional level

Think outside the silo & involve your “friends”: • Operating units – they control operating cash flow• Financial units – FP & A, Tax, Audit helps fin. cash flows• Even your banks

Model the future with measurable results• Interest Expense - Less borrowing vs. lower costs?• Bank fees• Staff costs - in & out of treasury?• Lower exposures – to FX loses or (unknown) market changes• Increases in debt capacity (more liquidity)• Access to increased number of 3rd parties for debt or equity


Treasury Metrics - Favorites

Key Metrics of Treasury Success All

Revenues < 1BN

Revenues > 1Bn

Reduced Borrowing Expenses 58 57 59Liquidity Targets 55 59 49Reduce Banking Expenses 51 53 51Risk Management Effectiveness 49 44 54Capital Structure Support 47 29 62Income Generation 28 36 24

Source: AFP 2014 Strategic Role of Treasury Survey (243 responses)

Create time horizons for liquidity and risk metricsTactical : time horizon < 90 daysStrategic : time horizon > 90 days


1. Cash on hand (by curr., entity, bank, etc)2. Free Cash Flow ($FCF) = op cash flow –

CAPEX – Dvds (compared to uses?)3. Cash Conversion Cycle (days) = DSO + DIO –

AP Days to pay 4. Burn rate ($ / day) = Avg. current liabilities /

cash on hand.5. Debt headroom (% or $) = debt used vs

credit limits6. Leverage = debt / FCF; debt / equity7. Ops cost = Treasury + bank + back office + FX

losses

Which of these does your TMS measure?

Treasury Metrics - Favorites


Tactical Targets & TrendsHorizon < 90 days Definition / CommentsLiquidity1. Cash to target2. Days cash on hand3. Debt Due (by mat. date)4. S/T Invest. (7 day mat.)5. Cash flow (% variance)

1. Actual to forecast or plan. Varies by business2. Cash to current liabilities (similar to DSO)3. Forecast principal due4. Forecast investments maturing5. Compare ops. and fin’ l flows to forecast

Risk1. % Hedged (30/60/90 dys)2. FX G/ L to target

1. Compare actual to policy2. Compare G/L by currency, by org unit

Operations1. 9AM Bal. Rpts (# / $)2. # incoming transactions3. # outgoing transactions4. # of interco. transfers5. Hours to reconcile

1. Bank inputs complete? On time?2. Show trends by org to measure workloads3. Show trends4. Show trends5. Time spent processing vs. planning


Strategic Targets & TrendsHorizon > 90 days Definition / CommentsLiquidity1. Free Cash Flow2. Cash Conversion3. Debt Utilization4. Available Liquidity5. Op cash flow as % EBITDA

1. Trend: Op cash Flow – CAPEX – Dvds2. Trend: DSO + DIO - DTP (days)3. O/S vs Total (% / $): 3rd party + interco.4. Cash + un-utilized credit lines ($)5. Profit is “leading CF indicator”, but trend to

op. cash should be parallel

Risk1. Exposure – Currency2. Exposure – Var. rate debt3. Financial Leverage4. Compliance5. Op error / error rate

1. Compare to policy by currency2. % or $ variable debt to total3. Ratio total debt to equity4. # of covenants (financial + non financial)5. # / % errors (need to define “error”)

Relationships (i.e. counterparties) & Other1. # global banks & accounts2. Cost of funds3. Fees Pd

1. Count by total and by legal entity2. After tax COF (% gross, net int.), $ Expense3. $ by business unit


ConclusionsSuccess constrained by too much processing, too little planning• Get ownership over cash flow statement• Set liquidity metrics (and rewards) by business levels• Acquire global cash visibility as a market hedge• Manage FX G & L (income statement)

Cost of “mistakes” set to rise – find “cheap” internal cash to reduce market costs / exposureBuild a business case based on “four flows” • Work – what is NOT getting done? • Cash – place exact amounts of “right” currency at right

time, in right place avoids borrowing• Accounting – faster cycle time, less global staff, no errors• Information – Why EOM instead of TODAY? Co. vs. Peer

performance?


Action Steps (Ranked easy to hardest)

1. Rationalize bank network & align for futurea. Fewer banks?b. Fewer accounts?

2. Set target cash balances (could be zero)3. Re-bid bank services at market prices; use

“best” ones to reduce processing time/cost4. Work with business units to establish joint

liquidity and risk goals5. Upgrade treasury technology & build in

KPIs


Action Steps (Ranked easy to hardest)

6. Set up pooling or netting arrangement at international entities

7. Create in-house bank8. Obtain analytical tools to measure risk

a. Outside (market, counterparties)b. Inside (operational)

9. Work with business units as internal consultant to set “real” risk limits

10. Imbed liquidity and risk limits into corporate profitability plans (RAROC) & set bonuses accordingly


Q & A

FECG Contact Information• www.thefecg.com• Bruce Lynn, CTP

Phone: 203-655-4806Email: [email protected]

Iowa How Does Treasury Measure Success.ppt...Financial Risk Analysis 4% Investment and Counterparty...

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