The treasury process allows organisations to minimise the cost of transactions, reduce organisation costs and bank costs, optimise the organisation’s finances and manage risks. The routine procedures or processes involved in treasury management are:
Table of Content
Treasury Process
Financial planning and risk management
The most common problem that leads to a shortage of funds in an organisation is the lack of efficient planning. Organisations need to plan the utilisation of available cash at minimum possible risk. Therefore, cash forecasting, budgeting and analysing investment options are necessary procedures that are required for effective cash management. Treasury managers plan, control and monitor market risks that organisations are commonly exposed to.
Market risks arise from negative market developments (such as adverse changes in money and capital markets), which, in turn, affect the valuation of an organisation’s assets. Risks may also arise due to changes in stock prices, interest rates and exchange rates.
Risk analysis strategy development
Once the treasury department has identified all potential risks, it needs to develop a risk strategy. This strategy would help in analysing the impact of each type of risk, possibility of these risks and measures to be taken to combat the impact of these risks on the organisation’s cash position. The treasury department identifies various future scenarios and develops a strategic vision for operating in such scenarios. The department later discusses the strategy with senior management, includes the changes suggested and communicates the strategy to other business functions.
Implementation and documentation: The next essential step in the treasury process is to implement and document the risk management strategy. Risk documentation process involves recording, reporting and tracking results of the risk management strategy.
Confirmation, settlement, reconciliation
As mentioned earlier, the treasury department is responsible for maintaining the cash position of an organisation. Therefore, all transactions carried from the organisation’s bank account to other banks or businesses are confirmed, settled and reconciled by the treasury department.
The main duties of the treasury department include processing all transactions in the organisation’s system, recording all transactions in the books, making payments, confirming all transactions and settling the payments on time.
Accounting
The treasury process also involves the accounting of all credit and debit transactions that took place in a period. This includes the accounting of debit/credit transactions, domestic and international wire, letter of credit fees, etc. In addition to these, the treasury department prepares approval requests to write off uncollectible accounts receivable.
Performance analysis reporting
The treasury process ends with the periodic reporting of the department’s cash management strategy, returns from investment instruments, relationship with banks and credit rating agencies, risk management strategy and process metrics. These reports are reviewed by the board and senior management to assess the viability of the treasury process and make appropriate amendments whenever necessary.
Treasury Policies
A treasury policy is a manual approved by an organisation’s board, which is meant to provide the treasury team with written guidelines on its roles and responsibilities, the standard treasury procedures, basis of performance measurement and the limitations of procedures. Treasury policies are based on an organisation’s long-term strategy and include areas like foreign exchange risk management, interest rate risk management, credit risk management, liquidity risk management, and capital management. In general, treasury policies are related to the treasury functions as mentioned below:
Let us discuss treasury policies related to each of these treasury functions in detail:
Funding and liquidity management
The treasury department’s main objective is to safeguard the organisation’s capital and assets. This requires periodical opinions of the board and top management. These suggestions are based on the organisation’s strategic priorities, economic and market conditions, investment opportunities, dividend policy, etc.
The resulting capital structure offers the organisation a high degree of financial flexibility at low capital cost. To maintain a financial balance and acceptable credit rating, the treasury department needs to take into account the overall level of borrowings and their maturity, the organisation’s liquidity levels, the total cash flow, Earnings Before Interest, Taxes, Depreciation and Amortisation (EBITDA), etc., on a statutory reporting basis or as required by the credit rating agencies.
Interest rate risk
The interest rate management policy of the treasury provides guidelines on how to borrow and invest at floating interest rates. For this, the treasury team establishes a historical correlation based on past data on interest rates and commodity prices. This information is later used to assess whether the organisation should borrow/lend on floating rates or fund a higher proportion of cash on a fixed rate of interest.
Foreign exchange risk
The earnings and cash flows of an organisation operating across borders are exposed to changes in the valuation of different currencies owing to geographic diversity of countries in which it operates. Therefore, the shareholders’ equity, cash position and financial earnings of the organisation are always subjected to foreign exchange risk.
The treasury department is therefore responsible to advise the organisation to minimise the foreign exchange risk. The organisation is required to hedge the currency risk against the functional currency (such as US dollars) by making the use of forward foreign exchange currency contracts. The overseas profits are translated by using average currency rates over a period of time.
Counterparty credit risk
An organisation is exposed to credit risk from operating activities (such as accounts receivables) and financing activities (investments in government securities, bank deposits, other short-term investments, etc.). This risk is referred to as customer credit risk. Customer credit risk is managed by the treasury in order to maintain a steady cash inflow for maintaining the working capital and operating cash within the organisation.
The treasury department establishes credit limits for all customers based on a specific rating criterion. Receivables outstanding are constantly monitored and any credit defaults are notified to the senior management. Counterparty credit limits are periodical- ly reviewed by the senior management and the company’s board once a year. Credit limits are decided in order to reduce credit risk, thereby mitigating possible financial loss due to counterparty failure.
