Managing Cash Balances (1) – The Treasury Function

1 The basic treasury functions

The basic role of the treasury function is to manage the liquidity of the business - ensuring that there is enough cash to fund operations and that surplus cash is properly invested.

This involves:

• cash forecasting
  

• investing surplus cash balances, both short-term and long-term surpluses
  

• raising funds - both short-term borrowings and long-term raising of finance from the issue of loan stock or shares either privately or on a stock exchange.
  

• management of policies regarding the giving of credit to customers and taking credit from suppliers
  

• managing risk, in particular the risk of interest rates changing and the risk of foreign exchange rates changing (if the business has dealings with foreign companies)
  

2 Centralised treasury function

A group of companies may decide to have one treasury team responsible for the treasury function of all companies in the group - this is known as having a centralised treasury function - as opposed to having a team in each individual company which is known as being decentralised.

Advantages of a centralised treasury function:

• more expert staff can be employed
  

• less spare cash need be held because it can be shared (ie transferred between) between companies throughout the group
  

• better interest rates for borrowings and for deposits of cash because it is arranged for the group as a whole. For example, if there are four companies in a group and each has about $125,000 surplus cash, then by pooling that the group could deposit $500,000 and is likely to get a better interest rate.
  

• easier foreign currency management because receipts in one company can be matched with payments by another company in the group in the same currency. This can substantially avoid the need for converting money from one currency to another and reduces the group's costs.

3 Disadvantages of centralised cash management

• less knowledge of local circumstances
  

• possible delays in handling cash transactions
  

• poorer relationship with local banks
  

• less autonomy for individual companies
  

4 Controls over cash receipts and payments

• Record receipts promptly, issue evidence of payment, count cash independently and bank it regularly. Restrict access to cash, payment systems and cheque stationery.

• Separate custody, recording and payment authorisation. Require supporting documents and approval limits; use independent bank reconciliations to identify missing, duplicated or unauthorised transactions.

5 Optimal cash balances

Companies will wish to keep some cash readily available (i.e. in their current account) for three reasons:

• Transaction motive - to be able to make regular day-to-day payments
  

• Precautionary motive - to be able to deal with any unexpected situations
  

• Speculative motive - to be able to take advantage of any special circumstances
  

However, companies will not wish to hold too much cash because they will be losing income that they could be earning by investing the extra cash. This will mean that although their liquidity is higher, they will be losing potential profit.

Companies need to take into account that delays in cash receipts might occur. For example:

• Postal delays if cheques are being used as payment
  

• Delays in paying in cheques
  

• Delays in the banking system - particularly if there are statutory holidays.
  

Companies can take action to minimise some delays. For example:

• Ensure that all cheques are banked the same day as receipt. This also minimises the risk of cheques going astray.
  

• Encouraging customers to pay by internet transfer rather than by cheque.
  

6 Statutory and other regulations

If cash is badly managed it can mean that funds are put at risk and that the company might be unable to reliably use its cash when it needs to - especially if there is an emergency. Therefore, statute and other regulations sometimes intervene to safeguard investors and members of the public.

Banks – Banks take deposits and provide credit. If many depositors seek repayment at once, a bank can face a liquidity crisis. Banks therefore face capital and liquidity requirements. The Basel III framework, developed after the global financial crisis and extended by later reforms, aims to strengthen resilience; implementation details depend on the jurisdiction.

Public authorities - for example, local councils, are allowed to invest only in very safe investments, paying little or no interest, so as not to put public funds at risk.

Trusts - a trust means, typically, that ownership of an asset rests with a trustee and income from the asset goes to beneficiaries. Sometimes, ownership of the assets eventually passes to the beneficiaries. For example, a relative could leave money for a child and the money would be held in a trust, managed by trustees and e the child reached the age of 21 (say) the child gains full control of the money. Pension funds are also often held by trustees. In most cases the law seeks to protect the long-term interests of the beneficiaries by restricting the type of investment that can be held so that the money is not subject to unreasonable, speculative risks.

7 Chapter 7 questions

Question 1

Which of the following functions would typically be carried out by the treasury department of a company? Select all that apply.

A   Foreign exchange risk management

B   Sales accounting

C   Investment appraisal

D   Investing surplus funds

E   Cash flow forecasting

F   Inventory control.

Question 2

What are the three motives for holding cash?

Question 3

What city gave its name to regulations formulated in 2010 to increase banks' liquidity?