TREASURY’S ROLE IN DRIVING FINANCIAL AND BUSINESS …

[Pages:31]TREASURY'S ROLE IN DRIVING

FINANCIAL AND BUSINESS

STRATEGY

BUSINESS BRIEFING

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BUSINESS BRIEFING TREASURY'S ROLE IN DRIVING FINANCIAL AND BUSINESS STRATEGY

CHARTERED ACCOUNTANTS AUSTRALIA AND NEW ZEALAND

Chartered Accountants Australia and New Zealand is made up of over 100,000 diverse, talented and financially astute professionals who utilise their skills every day to make a difference for businesses the world over.

Members of Chartered Accountants Australia and New Zealand are known for professional integrity, principled judgement, financial discipline and a forwardlooking approach to business.

We focus on the education and lifelong learning of members, and engage in advocacy and thought leadership in areas that impact the economy and domestic and international capital markets.

We are a member of the International Federation of Accountants, and are connected globally through the 800,000-strong Global Accounting Alliance and Chartered Accountants Worldwide which brings together leading Institutes in Australia, England and Wales, Ireland, New Zealand, Scotland and South Africa to support and promote over 320,000 Chartered Accountants in more than 180 countries.

THE ASSOCIATION OF CORPORATE TREASURERS (ACT)

The Association of Corporate Treasurers (ACT) sets the benchmark for international treasury excellence. As the chartered body for treasury, we lead the profession through our internationally recognised suite of treasury qualifications, by defining standards and championing continuous professional development.

We enable and support treasury professionals throughout their careers by:

? Providing clear treasury leadership and a trusted dynamic global network of experts

? Raising the profile of the profession, growing its influence and championing its success

? Delivering high level "real economy" influence among policy makers and regulators.

The ACT competency framework sets the global standard for treasury by defining the skills, knowledge and capabilities needed by treasury professionals to operate successfully in today's challenging business climate. Our qualifications have been mapped against this to offer a progressive learning pathway for those working in and with treasury, to build capability and support business talent.

As the world's leading professional body for treasury with members in over 100 countries, we facilitate networking and knowledge sharing in the treasury and business finance communities. We launched the Treasurer's Wiki as a free global resource. We provide informed and unbiased technical advice and best practice guidance through our briefing notes, technical updates, blogs and webinars. We seek the views of members and practitioners on key issues and contribute and respond to proposed policy, regulatory and market practice changes.

ACT is a member of the International Group of Treasury Associations (IGTA) and the European Association of Treasury Associations (EACT), and is an Affiliate of the International Federation of Accountants (IFAC). Treasury and accountancy go hand-in-hand. We work in partnership with leading accountancy bodies from around the world to offer a fast track route to becoming ACT-qualified and to raise awareness of the value qualified finance professionals bring to business.

Copyright ? October 2015 Chartered Accountants Australia and New Zealand and the Association of Corporate Treasurers. All rights reserved. DISCLAIMER: This document was prepared by Chartered Accountants Australia and New Zealand and the Association of Corporate Treasruers. The information in this document is provided for general guidance only and on the understanding that it does not represent, and is not intended to be, advice. Whilst care has been taken in its preparation, it should not be used as a substitute for consultation with professional accounting, tax, legal or other advisors. Before making any decision or taking any action, you should consult with an appropriate specialist or professional. All information is current as at October 2015. Chartered Accountants Australia and New Zealand ABN 50 084 642 571 (CA ANZ).

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BUSINESS BRIEFING TREASURY'S ROLE IN DRIVING FINANCIAL AND BUSINESS STRATEGY

FOREWORD

CORPORATE TREASURY PLAYS A CRITICAL ROLE IN FINANCIAL AND BUSINESS STRATEGY. IT'S ESSENTIALLY THE LIFE-LINE OF AN ORGANISATION ENSURING STEADY CASH FLOW, SPEAR-HEADING INVESTMENT STRATEGIES, MANAGING LOANS AND BALANCING RISK AND REWARD.

Over the last few years, the treasury professional's role has become even more complex and challenging largely because of the volatile economic and political climate. CAANZ and ACT have collaborated to produce this business briefing. It's designed to shed light on how the treasury function operates and sets out what to consider when performing treasury activities. The briefing covers the following key areas: ? Governance ? Corporate funding ? Cash management and liquidity ? Risk management. Given the increasing significance of treasury for businesses right across the globe, This briefing will assist you in improving your understanding and management of treasury, and enhance your organisation's financial and business strategy.

Lee White FCA

Chief Executive Officer Chartered Accountants Australia and New Zealand

Colin Tyler MCT

Chief Executive Association of Corporate Treasurers

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BUSINESS BRIEFING TREASURY'S ROLE IN DRIVING FINANCIAL AND BUSINESS STRATEGY

CONTENTS

5

INTRODUCTION: A NEW BUSINESS LANDSCAPE

12

CASH MANAGEMENT AND LIQUIDITY

27

CONCLUSION

7

GOVERNANCE

9

CORPORATE FUNDING

16

RISK MANAGEMENT

23

TREASURY OPERATIONS AND CONTROL

28

TREASURY CHECKLIST

30

GLOSSARY

31

CONTACT DETAILS

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BUSINESS BRIEFING TREASURY'S ROLE IN DRIVING FINANCIAL AND BUSINESS STRATEGY

INTRODUCTION: A NEW BUSINESS LANDSCAPE

FINANCIAL STRATEGY AND BUSINESS STRATEGY TOGETHER FORM CORPORATE STRATEGY. FINANCIAL STRATEGY DEPENDS ON THE BUSINESS STRATEGY ? BUT BUSINESS STRATEGY IS ENABLED OR CONSTRAINED BY THE FINANCIAL STRATEGIES AVAILABLE, AND BY THE CHOSEN FINANCIAL STRATEGY. THESE KEY STRATEGIC ISSUES ARE THE CONCERN OF AN ORGANISATION'S BOARD: DIRECTORS MUST BE COMFORTABLE WITH AND BUY INTO THE ORGANISATION'S FINANCIAL STRATEGY.

Treasury, the interface between the business and its financial providers, is a key element of financial strategy. Every organisation faces treasury issues, even if it does not have an identified treasury department. Where this paper refers to treasury, this may be a separate department or part of the responsibilities of the wider team. The treasurer referred to may be a separately identifiable role or part of the responsibilities of a broader role depending on the size and complexity of the organisation. At the strategic level, treasury is about advising on appropriate choices, the trade-offs and compromises involved when financial decisions are taken. There are three interrelated questions that are fundamental to treasury decision making:

WHAT ASSETS DO WE

INVEST IN?

nature of the business or from the financing chosen. Indeed, it is not possible to take sound decisions about any one of the key questions without influencing and taking account of the answers to the two other questions; they are interdependent.

Importantly, the answers to all three questions are also contingent on external factors. The interrelationship of those external factors and the three questions are usually too complex to be completely certain. Accordingly, we are in an area where judgment is required ? from the outset and as conditions change.

WHAT ASSETS DO WE INVEST IN? This question is central to the business strategy and to the financial criteria for investing. It boils down to whether the investment will earn enough and/or generate sufficient benefit to cover the cost of the funds and compensate for the risks involved.

HOW DO WE RAISE THE MONEY?

HOW DO WE CONTROL THE RISK?

Financing considerations for each organisation are different as there will be different answers to these three questions. For example, a utility company and a confectionery manufacturer will have very different responses. The timehorizons to be taken into account and the risks are different too ? whether arising from the

"Investing" is any use of resources for future benefit. It covers not only acquiring property, plant and equipment and M&A or intangible property like patents and know-how and brands but R&D, staff training and marketing programmes.

HOW DO WE RAISE THE MONEY? An organisation needs to know how much money it has available to invest and how much more it could raise, on what terms, at what cost and where from.

Raising the funds is the responsibility of the treasury department or those responsible for treasury, which needs to consider a number of questions, for example:

? Is additional finance raised as equity, debt, a hybrid or a combination?

? Does what is being invested in lend itself to asset-based finance?

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BUSINESS BRIEFING TREASURY'S ROLE IN DRIVING FINANCIAL AND BUSINESS STRATEGY

(I.e. could it be rented or leased and at what cost?)

? Are there other existing assets that could be more easily financed, releasing funds for the new investment?

? To which providers of funds does your organisation have access?

HOW DO WE CONTROL RISK?

The organisation's risk management policy will cover providers of funds. Questions to be considered include:

? Is the cash flow impact of servicing and, except for equity, eventually repaying the funding and any other conditions of the funding (i.e. covenants and default wording) acceptable or manageable for the organisation and for the providers of the funds?

? Are the risks from the investment itself acceptable, when compared to the business to which it contributes?

? Is the overall business risk, including the total funding and cash flow risks, acceptable or manageable for the organisation and the providers of funds?

Identifying and managing some of those business risks, or enabling the business to adapt to make the risks manageable, is also a part of the treasury brief. In particular this applies to risks such as those arising from movements in interest rates, foreign exchange rates, commodity prices and inflation.

Some of these risks will be managed through structural decisions about the business, for example, the location of a new plant may affect currency exposures, access to finance or the security of supply for input commodities. Sourcing decisions and flexibility in sourcing of materials, components or finished goods will also affect how risk is managed.

Other risks will not be subject to such structural solutions but may be addressed through contract negotiation. For example, the pricing formulae in contracts may permit adjustments for interest rate, exchange rate or commodity price changes. Other risks will just be accepted and monitored.

Addressing these questions, and the day to day funding and investment of surpluses, makes up treasury operations.

Each section begins with a diagnostic questionnaire that highlights some of the key issues a senior business manager should consider. The questions are also consolidated into a treasury checklist at the back of the paper for quick reference. If the answer to a question is "no," then this is a prompt to ask further questions and/or take action. Very few questions, if any, should be not applicable.

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BUSINESS BRIEFING TREASURY'S ROLE IN DRIVING FINANCIAL AND BUSINESS STRATEGY

GOVERNANCE

1.1 TREASURY'S ROLE AND OBJECTIVES

Are treasury's role and objectives clearly defined and aligned with your organisation's objectives? Is the financial strategy articulated and integrated with your business strategy? Has the Board's risk appetite been quantified and clearly communicated to treasury? Do the CFO, Audit Committee and the Board of Directors as a whole understand the treasury issues and do they enjoy open lines of communication? Treasury plays a key role in determining the organisation's financial strategy, working out how to finance the business strategy and how to manage the risks that follow from this. Treasury therefore needs to contribute to the mix of business and financial strategy, namely the corporate strategy, by setting out what is possible financially, at what cost and with what risks as the business and the environment develop.

In order to do this, the treasurer needs to feed into the business plan process. If, for example, the growth plan cannot be funded, the treasurer needs to advise senior management and perhaps suggest plan modifications or phasing the plan in over a longer time period.

FINANCIAL STRATEGY

Decide on optimum financing, hurdle rates, dividend policy, financial market risk, which market to raise debt or equity, counterparty limits

+

BUSINESS STRATEGY

The financial strategy judges optimal financing based on the following three factors:

RANKING OF CAPITAL

EASE OF FINANCING

COST OF FINANCING

LEVERAGE

HOW TO MEASURE

HOW TO MONITOR

MARKETS

DIVERSITY OF SOURCE

DIVERSITY OF MATURITY

Overall financing and risk management guidelines are derived from the financial strategy and set the general approach to funding, managing currency and interest rate risks, investing surplus funds, setting counterparty limits etc., so enabling creation of treasury policies. From these, the approach to treasury is derived, such as degree of centralisation, services offered and whether it will be a cost, service, value-added or profit centre.

Quantification of risk appetite by the Board is not always easy. The potential impact on the financial statements, such as the Board's maximum acceptable fluctuation in earnings is one possible measure of risk appetite. To assist the Board in understanding its risk appetite, the treasurer will need to model various scenarios such as interest rate and foreign exchange rate movements, to calculate the potential earnings impacts but most importantly impacts on cash flows and (re-)financing capabilities. Stress testing outcomes should also be undertaken.

Decide on which markets, with which products, and how they are delivered

=

CORPORATE STRATEGY

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BUSINESS BRIEFING TREASURY'S ROLE IN DRIVING FINANCIAL AND BUSINESS STRATEGY

1.2 TREASURY POLICY

Is treasury policy aligned with financial strategy (itself part of corporate strategy) and the approach to risk?

Is treasury policy approved by the Board and reviewed at least annually?

Does the treasury policy set limits for each financial risk?

Is adherence to treasury policies reviewed by the Board and independently audited? All well managed treasury functions have a written treasury policy with a process to manage regular updates. Treasury policy is a mechanism by which the Board and management can delegate fundamental financial decisions about the business in a controlled manner. It should give treasury staff written guidelines on what they are responsible for, how they should go about their responsibilities, what their boundaries are and how their performance will be measured. These can be developed in formal procedures.

As an example, the treasury policy document should explain:

? Risk management objectives which should reflect the organisation's goals, risk appetite and sources of risk for the specific business and the economic environment in which it operates

? The risk management framework to be adopted by the organisation (i.e. identify, assess, evaluate, respond, report)

? For each financial risk, what is the risk and why is it being managed, taking into account the organisation's risk appetite

? Risk measures which will be used to set target outcomes and model the likelihood of those outcomes. This may include sensitivity analysis with indicative probabilities attached.

? Procedures for the day to day management of risks, including:

-- The delegation of responsibility for managing risk

-- How treasury will relate to business operations where risks are identified and/or being managed

-- Risk targets and limits based on an acceptable level of risk, adapted as the organisation evolves

-- Performance reporting/feedback mechanisms.

The Board has ultimate responsibility for risk management and for approving risk policies. In larger organisations, risk management tasks may be delegated ? but not abandoned ? to a subcommittee of the Board, often called the Risk Management Committee (RMC).The contribution of the treasury function is to recommend

financial risk management (and potentially other) policies and to ensure that the approved policies are followed.

The Association of Corporate Treasurers was created to provide education and support to those involved with corporate treasury.

1.3 QUALIFIED PERSONNEL

Is your treasury team adequately educated/ qualified/trained and supported at each level?

Treasury differs from other finance roles, with an emphasis on cash, risk and markets. The complexity of instruments, systems and interactions with the business, both operationally and strategically, mean that some of the skills needed for treasury are specialised and demanding.

Many markets have become more difficult and expensive since the 2008 Global Financial Crisis (GFC). Greater risk awareness within organisations means more colleagues interacting with treasury, often wanting to take very long-term views in planning business development. Treasurers can, day to day, undertake transactions which have risks or consequences their Board and operational colleagues may not, initially, fully understand. The treasurer should be able to articulate these risks or consequences as and when required.

In smaller organisations, or where treasury is more decentralised, staff may carry out treasury activities on a part time basis. Emphasis may then be on training in specific treasury procedures rather than on wider education. Subsidiaries in a group will need help from the head office. In smaller organisations, some senior level familiarity with treasury issues is important to be able to recognise developing issues and be alert to the need to secure specialist treasury advice from time to time.

Organisations without specialist derivative product and financial risk knowledge are at greater risk of being mis-sold (or mispurchasing) overly complicated or inappropriate derivatives by banks. Numerous case studies exist of organisations suffering multi-million dollar losses as a result of badly chosen derivatives, such as Procter & Gamble in interest rate derivatives and South African Airways and Greenpeace in foreign exchange derivatives.

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