Treasury Function in a Company: Management Best Practices

Treasury teams are pivotal to the success of their organizations, but are often misunderstood or underestimated. The treasury function in a company serves as a kind of mini-bank for the firm, overseeing all financial resources. Without prudent cash management strategies, firms risk running out of money. By following these treasury management best practices, your business will be better positioned to thrive, save money, and respond quickly to change.

What Is Treasury Management?

Treasury management teams oversee a company’s cash flows. They manage the amount held and its liquidity using two levers: the size of the balance sheet and the relative stickiness (liquidity) of assets and liabilities held. Managing these two levers supports an organization’s fundamentals, making sure there is enough cash for financial transactions ranging from pizza delivery tips out of the petty cash box to an opportunistic merger or acquisition.

Treasuries also play a crucial role in companywide financial decisions and strategic planning. For example, if the board decides to buy a business, the treasury team will help determine the company’s fit from a balance sheet perspective and free up the financial resources to purchase it.

What Does Treasury Do in a Company?

A corporate treasury team handles five key functions: asset liability management (ALM), funds transfer pricing (FTP), trading and hedging, portfolio management, and special projects and integrations.

1. Asset Liability Management

Companies hold a range of instruments on balance sheets and each has its own characteristics and behaviors. The ALM team is concerned with the blend of assets and liabilities, as well as any mismatches between maturity, currencies, and interest rates.

ALM is highly significant for treasury management in banks because its fundamental purpose is borrowing and lending money. As you can see, banks are generally more leveraged through their increased use of liabilities relative to equity capital.

Corporate finance teams cannot overlook ALM, however. It’s generally cheaper to borrow short-term liabilities and invest in long-term assets, so there’s a natural tendency for companies to stretch this funding mismatch to the limit. This can come crashing down during market flashpoints when credit dries up and liabilities become harder to shift. An ALM function monitors this liquidity horizon and performs scenario planning to establish limit buffers and advise on any changes that can be observed in advance.

Optimizing assets and liabilities proactively increases profitability and business opportunities, and this is not just true for banks. Here are some examples of how the treasury function in other companies might do this:

• Offering consumer credit services for direct-to-consumer vendors (e.g., supermarkets, e-commerce) with negative cash conversion cycles.
• Enacting share repurchase schemes enacted at opportunistic periods
• Factoring receivables to gain a competitive advantage by winning new customers through attractive payment terms

2. Funds Transfer Pricing

Treasuries price liabilities for use in everyday asset-generating activities. The FTP reflects the cost of liabilities and is charged to a business unit when it wants to originate a new asset. Unlike the cost of debt figure, which can be represented as a standalone loan or benchmark bond yield, the FTP represents a fully loaded cost. It is the overall weighted average cost of all liabilities plus the internally shared costs of the business minus treasury profit.

Funds transfer pricing is the process of costing a balance sheet and then setting prices for asset creators or liability gatherers to pay or earn for their respective tasks. Without this, there would be a free-for-all, with profitability and balance sheet structure left to their own devices.

3. Trading and Hedging

The treasury function is responsible for hedging companywide interest rates and foreign exchange (FX) risk, using derivatives to balance the books. Depending on the sophistication of the business, these financial risk management techniques can range from FX spot trades to long-term interest rate swaps.

4. Portfolio Management

Treasuries are financial asset managers for their company, investing spare cash on the balance sheet to generate a return (and lower FTP). This type of investment management is often a creative exercise that involves a search for yield, liquidity, and capital efficiency.

5. Special Projects and Integrations

Overseeing all parts of the business and being agnostic toward any specific business line makes the treasury a useful partner for integrating acquisitions or spearheading IT transformation initiatives.

How Do Treasuries Impact Business Performance?

The treasury function in a company is in charge of all mechanisms that drive financial returns—not just cash flows or investment portfolios. If managed correctly, treasuries are flexible and significant contributors to financial performance.

Attention on business performance tends to focus on the income statement—namely, revenue growth and profitability. Yet the core (capitalist) purpose of a business is to provide returns to its shareholders, and the standard metric for that is return on equity (ROE). If we break ROE down into its constituents using the DuPont analysis formula, it becomes apparent that the role of a treasury touches every aspect.

If we look further into these components, we can see the broad role that treasury contributes:

• Net profit margin (profit/sales): Searching for cheaper borrowing costs increases contribution margin = more competitive
• Asset turnover (sales/assets): Getting more yield out of assets through ALM and portfolio management = more revenue
• Financial leverage (assets/equity): Managing debt to optimal levels = more opportunities

Outside the C-suite, very few teams in a company can cover all these bases. Yet the unsung treasury department does.

How to Optimize the Treasury Function in a Company

It’s essential to build a capable, autonomous treasury team and manage it wisely. Here are eight ways to do that:

1. Create a Centralized Treasury Structure

Starting at the top, a business must place its treasury in the correct area of the organization. An effective team must be:

• Impartial: Not allied or biased toward any commercial area of the business.
• Empowered: Both in terms of human and capital resources and flexibility to “roam.”
• Incentivized: Without treasury being a profit center, team members must have quantifiable goals.

Too many companies fail because their treasuries are operational offshoots of corporate finance teams working out of back offices far from the corporate hub. When treasury teams are treated as afterthoughts, their lack of resources and support can lead to cash flow problems and other potentially fatal issues. Instead, the corporate treasurer should report to the CFO directly and be relied upon as lieutenants in the business for their insight into the balance sheet. Similarly, all treasury roles and functions should be contained within the same team. Trying to create a “cloud team” with roles scattered throughout the company will ultimately result in crossed wires and a lack of effectiveness.

Here’s a recommended breakdown of key functional roles and focus within treasury teams:

To illustrate why it’s important to contain all of these roles in the same team, here’s a simple example of the four pillars working together in a sequence of steps:

1. Operations notes that terms on a lease have been incorrectly interpreted, and it’s actually longer.
2. Risk managers raise the effect of the longer asset life and confirm that liquidity horizons have shortened due to shorter-dated borrowing.
3. Relationship managers canvass banking contacts and find willing lenders for a revolving credit facility.
4. The investment management team draws down the loan, using a foreign exchange swap to convert a portion to cover short-term requirements.

Keeping these experts together makes it easier to develop efficient processes as needed to solve complex financial problems.

2. Think Carefully About Compensation and Incentives

It’s also important to get compensation and incentives right. This ranges from how the team is created to where they’re seated in the office. Treasuries interface externally and thus must project confidence and the appropriate corporate image to external parties.

Because the team is not a profit center, and its members’ compensation isn’t linked to the P&L, there can be perverse incentives that lead to sloppy internal processes and practices and leave a company open to financial risks. For example, taking an ultra-high-risk policy of raising long-dated cash and lending it out in the short term isn’t a commercially sound practice outside of severe market stress. But if the treasury team is not incentivized to be cautious, they might take this option because it’s easy.

Establishing suitable and compelling incentives for treasury staff reduces agency costs. Variable compensation related to funds transfer pricing movement is an interesting tool for measuring holistic team performance.

3. Get FTP Right

Costing up a balance sheet is an arduous task, and it can become difficult if there’s a high turnover of items and/or weak IT treasury management systems. Getting it right, though, will ensure that new business activities using the balance sheet add value.

In doing this, having an agreed-upon floating interest rate benchmark (the way LIBOR was once used) for the whole company is the best method for pricing up FTP. This removes arbitrage opportunities and interest rate curve risk, and it makes things easier for the ALM team’s monitoring.

It’s also worth mentioning that FTP should be disassociated from credit risk. Credit/deal teams should price deals on a case-by-case basis, with counterparties scored for risk and then charged appropriately on top of FTP. This further establishes the agnostic nature of a treasury toward the business: The team is an enabler, not an arbitrator.

4. Communicate Effectively

The treasury constantly monitors market conditions and the balance sheet. As a result, it’s able to provide important financial news to the company and translate macroeconomic events into potential risks and opportunities. Instead of simply forwarding information, treasury teams should connect the dots to business objectives and offer actionable insights to help leaders make informed decisions.

Reporting a business’s cash position is a vital end-of-day reporting task, but a treasury team shouldn’t stop there. Reports to the executive committee ought to be concise and not just a dump of mundane cash balances.

When reporting data, focus on these key metrics:

• Liquidity horizon (how long the company would survive if liabilities stopped rolling)
• FTP cost
• Weighted average yield earned on assets under your control
• Value at risk (VAR) of assets and derivative positions

Many stakeholders find financial reporting difficult to parse. Using a traffic light system helps establish relativity and emphasize the urgency of any financial risks. Equally important is adding commentary to the data to explain qualitatively why something has changed.

5. Shop Around for Partners

Liquidity management depends on external partners. Treasuries are buy-side institutions. They need market makers to provide them with financial products ranging from straightforward deposit accounts to esoteric derivatives. Treasury teams must shop around to develop a deep bench of liquidity providers.

An effective treasury should manage external clients in the same way that a sales-focused SaaS startup would. Maintain a CRM with links to financial institutions, brokers, and funds, and rank their pros and cons. This will ensure competitive pricing and a large phone book of liquidity providers for managing market risks.

Electronic trading platforms are great for getting good comparisons on pricing, saving time, and measuring execution performance.

6. Avoid Unnecessary Risk

The investment portfolios that treasuries manage are the equivalent of the change that you keep in a jar by your front door. This money is white-hot and could be deployed the next day. Investing it is important, though, because the yield gained lowers the dead-weight loss of undeployed capital and can bring tangential hedging and counterparty relationship benefits.

The three pillars of treasury portfolio management are liquidity, financial risk, and capital efficiency. These conservative targets differ from those of most other portfolio managers (notice the absence of yield). They might even appear boring to some. Still, it’s possible to employ certain instruments in cash management activities in interesting ways.

Regardless of the targets you choose, effective cash management requires prudence. No one will remember the treasurer who earned a humble 50 basis points of yield on their investment portfolio, but everyone, including the press, will remember the London Whale who lost $6.2 billion.

7. Take the Time to Build the Right ERP

Treasurers can’t operate to their full potential without effective software to splice up the balance sheet and communicate liquidity positions and risk exposures. Financial markets move by the second, and if you don’t have real-time visibility then you will be chasing shadows trying to reconcile positions. It’s essential that treasury management systems be able to account for a full range of functionality to ensure smooth crossover of workflows—the fewer systems, the better.

Treasury software is notoriously difficult to get right. Prepackaged solutions promise the world but require constant tweaking to ensure that internal trades and movements are captured and internal controls are enforced. Often, the enterprise resource planning (ERP) software is a derivative of a trading platform or accountancy ledger software, which can mean that treasury functionality is a compromised add-on.

Internally built software is typically tailor-made but becomes a mid-term engineering task. It’s worth investing in getting it right, however, because manual processes are prone to error. Artificial intelligence, for example, seems almost ideal for cash flow forecasting.

8. Be a Good Internal Partner

A treasury function can counsel and mediate between asset- and liability-focused teams. In banks, this is the deposit takers and lenders, but in a corporation, it could be the property team and the payables department.

Being impartial and involved with the business units, and providing solutions over roadblocks will ultimately help the wider organization and increase buy-in.

What Are Fintech Treasury Management Best Practices?

When establishing a treasury function, fintechs must prioritize flexibility, collaboration, and building external partnerships. These companies occupy an interesting niche in corporate finance. They often highlight how their business models differ from the larger companies they’re looking to disrupt. One manifestation of this trait is the higher emphasis on technology and marketing than on financial operations, which often leaves treasury relegated to a role in a sprawling, undifferentiated finance team.

Some general tips for fintechs seeking to establish a corporate treasury function include:

1. Ensuring that the first CFO can comfortably wear the “capital markets” and “bookkeeper” hats. This will keep staffing efficient and promote calm within the startup’s financial culture.
2. Getting the CTO to commit to a stable roadmap for back-end technology. Having a beautiful customer-facing app and an Excel-based Medusa of an ERP function is a recipe for disaster.
3. Building external counterparty relationships. Banks and traditional financial intermediaries may shut the door to a fintech if they fear disruption. Framing the relationship as a partnership and offering the sheen of being associated with a fintech can alleviate this.
4. Considering allying with tier 2 (“mid-market”) banks. These banks are chasing market share and differentiation gains against the entrenched elite.
5. Leveraging personal links from your VC and angel investors. When a bank smells a future IPO payday, it may offer concessionary services to establish an early relationship and ultimately win capital markets mandates.
6. Incorporating pricing analysts into the front and back office. Many fintechs, for example, offer margin-free FX transactions. If this is a straight pass-through of rates achieved from wholesale providers, then that’s fine. However, if the company is losing money on these transactions, the cost must be referenced in the overall marketing customer acquisition cost. Leaving this as the problem of the treasury will result in unrealistic expectations about the unit economics of the business.

How Effective Treasury Management Benefits Your Company

A corporate treasury is a strategic partner that touches virtually every financial transaction a company makes—it’s not just the keeper of the bank accounts and the investment management team. If there are three things the treasury function for a company should aim to do, it’s these:

• Use the balance sheet as a ship’s sail for driving business growth.
• Connect the dots between real-world events and the parts of the business they affect.
• Work toward macro-level business goals instead of a team-level P&L.

This will promote a robust balance sheet that can generate the marginal gains required to compete in a rapidly changing and responsive business world.