Treasury for Non-Treasurers: Crossing the Chasm (Part II)
Introduction In “Treasury as a Strategic Function”, we explained why Treasury matters to you, the Non-Treasurers. Later articles discussed how operational and strategic treasuries in the chasm offer limited value. Real value-add comes from strategic treasuries that have crossed the chasm. The previous article mentioned that amounts, cultures, and contexts push treasuries into the chasm. When you and treasury want to take action, you can’t change the underlying business cashflow amounts – they are what they are. Culture and context, on the other hand, can be changed. This article will show how treasuries emerge from the chasm by doing precisely that. This solution may seem unconventional – it’s rarely mentioned in standard articles and textbooks – but as the problem isn’t financial, neither is the solution. The issue stems from people in and outside of treasury, so change must focus on them. Note for non-Treasurers: As an organisation insider, you can request and support treasury’s evolution into a strategic function valuable to everyone, especially during crises. But, understanding the relevant context and cultural elements is crucial for formulating practical next steps. For suppliers, it’s similar; your products and services are tools for operational and tactical treasuries, often sold on price. However, when offered with appropriate technical and soft know-how relevant to each specific client, they become solutions for treasuries that are or want to be more sophisticated. These are sold on value, not price. These benefits underscore why mastering ‘soft skills’ like culture and context change is vital for all of you. Types of treasuries Let’s revisit the different types of treasuries before exploring them in more depth. While Figure 2 shows each treasury type in a distinct quadrant, all types except the basic treasury build upon each other. They progress layer-by-layer through operational and tactical levels until the function reaches its pinnacle in a few companies like IATA and GE Capital: those with a value-adding, external-oriented organisation. See Figure 3. Figure 2 highlights the challenge faced by tactical treasuries. As the saying goes, “A servant cannot serve two masters.” These treasuries have conflicting priorities and will never match the effectiveness of a strategic treasury. Crossing the chasm brings clarity to the purpose of treasury and, therefore, to its ability to effectively deliver material value to the organisation. Bridging the chasm methods In this section, we’ll explore examples of three different methods for bridging the treasury chasm. Detailed information is provided in the appendices for those interested in the general frameworks applicable to any organisation. Method 1: Out of sight, out of mind This method was the first I encountered in my professional career, though I didn’t realise it followed a successful standard framework at that time. While working for IBM Europe, we faced a challenge: some subsidiaries were borrowing while others were lending, but not to each other. This inefficiency cost the company money and exposed the group to material risks if one of the cash-holding banks were to fail. However, IBM’s decentralised structure meant the head office couldn’t force subsidiaries to lend to each other. Our solution? Create a function with a different culture in a new context: To change the context, we: To change the culture, we: The internal bank started with lending and borrowing only. Voluntary participation meant subsidiaries saw it as an opportunity, not a threat. Even in the first year, they gave 95% of their business to the new entity. The function grew rapidly, taking over customer financing activities and delivering improved services. It became a successful value-adding, company-oriented function. I learnt a crucial lesson later on, which I now pass on to you: implementing and creating a new culture isn’t enough. It must be nurtured until firmly embedded both inside and outside the function. In IBM’s case, this wasn’t fully achieved, partly due to Lou Gerstner’s top-to-bottom restructuring in the 1990s. As a result, the function arguably went back into the chasm. It was better than before but didn’t reach its full potential. The general framework for Method 1 is in Appendix 1 of the Treasury for Non-Treasurers (Appendices) article. Method 2: Leadership led To keep the article concise, I’ll provide fewer details for this and the following method. The underlying principle in all methods is the same: change the culture to an external focus. While Method 1 creates a new environment with a voluntary focus on external customers, Method 2 establishes an environment where delivering what’s wanted externally is mandatory. Method 2 is straightforward: 2. Senior staff lacking the necessary technical skills or attitudes are replaced with people with the right skills and mentality. 3. Junior staff must adapt quickly or move on. Example: The ABB Merger When Asea and Brown Boveri merged in 1987, CEO Percy Barnevik aimed to create a “federation of national companies” supported by global “free-standing service centres”. He sought staff with “exceptionally open minds… who don’t passively accept it when somebody says ‘you can’t do that’” (Harvard Business Review). One of these free-standing service centres was a new financial services function. This structural and cultural shift shocked the previous Swedish and Swiss company cultures. Many employees lost their jobs and were replaced. New hires in treasury and financial services brought a banking mentality, serving both internal and external customers. Having worked with their financial services division in Asia from 1995 to 2000, I observed that their treasury centres (internal banks) were often indistinguishable from external banks. The transformation succeeded. ABB’s Treasury was considered world-class until the early 2000s when they faced a company-wide black swan event. They still maintain an impressive treasury function today. It’s literally that simple. For the general framework of Method 2, see Appendix 2 in the Treasury for Non-Treasurers (Appendices) article. Method 3: Treasury-led This third method is more niche. While I haven’t seen it used in treasuries, I include it here as it could be appropriate in certain circumstances and potentially deliver more value than the other methods if implemented successfully. This method applies to companies that allocate time to employees…
Nicholas
How SAAS companies get burned by exchange rates
This article is a contribution from one of our content partners, Bound We 💜 finance teams from tech companies We spend a lot of time here at Bound talking with finance teams from venture-backed tech companies. Like most of the work conversations you probably have, our conversations follow a general outline like this: “Hey, Where you calling in from in the world?” [insert your favourite location]. Oh cool, my cousin lived there for a few years. She always said nice things. …… Wait for it…… here comes the obligatory weather comment… “Well, you’ve got better weather than us right now. I’d switch [weather-related complaint] for your [generic weather compliment that is, at best, loosely accurate].” Then the conversation turns to foreign cash flows–which some people might find boring, but we get pretty excited about here at Bound. After all, this is what we do. Why these finance teams talk about Bound Finance teams at growth-stage tech companies use Bound’s app to take foreign cash flows that normally bounce around with exchange rates and make them more stable and predictable. Classic use-cases for using Bound: Companies with these use-cases, use Bound’s technology to make these foreign cash flow streams more stable and predictable almost overnight. How exchange rates can hurt SAAS companies 🔥 One situation that comes up a lot with SAAS companies is the headache of foreign revenue contracts. Here’s an example of how exchange rates can potentially burn saas companies with a lot of international customers. THE SETUP Let’s pretend we’re a UK-based SAAS company with European customers. We report our finances in GBP. This is a fictional example roughly based on 2022 and 2023, but also includes simulated exchange rates into the future. We invoice monthly in arrears and recognize revenue evenly over the contract. THE SALE We sign a new contract with a new customer. Yeah! European customers don’t like paying in GBP, so we price European customers in EUR. The new contract is worth EUR 25,000/month for 24 months–EUR 600,000 total. Let’s pretend we sign the contract in Jan of 2023. The GBP/EUR exchange rate is about 1.125 at the time of contract signing. That’s roughly where the rate was for the first half of 2023. We’ll expect GBP 22,223.80 per month in revenue. Based on that rate, the sales team just booked GBP 533,371.26 . Nice work team! THE FIRST INVOICE 30 days later, we invoice the customer EUR 25,000 and record our GBP 22,223.80 in revenue. Of course, over the course of the month the exchange rate didn’t stay perfectly stable. We’ll pretend the GBP/EUR rate moved a little. Let’s say it’s now 1.127. Not a big deal, GBP 22,178.85. Whatever. GBP 44.95 isn’t a big deal. I can just write down our revenue a little, take a small currency loss or maybe I’ll just shrug this off. THE PAINFUL GBP RALLY But now let’s run a GBP-strengthening scenario for the remaining 23-months. At the time of writing, in early December 2023, GBP/EUR is up to 1.17. (This is mostly the true story of GBP/EUR over 2023) I’ve also thrown historic GBP/EUR data into a statistical rate simulator and told it to run a realistic GBP-strengthening scenario. Let’s see how our company does here for the rest of the year. So, that GBP 44.95 problem in the first month, that we brushed past, ended up being a GBP 63,525.13 problem over the course of the contract. That figure is harder to ignore, especially when you figure we have 50 customers with similar contracts. If the same scenario with all 50 of our European customers, we’re looking at currency losses or revenue write downs in the ballpark of GBP 3,000,000. And remember, currency losses aren’t just paper losses. This has a real impact to our GBP cash flow. THE MESSY RENEWAL One last problem. The renewal. The rate at renewal time was all the way up to 1.19. The customer is happy and wants to renew at EUR 25,000/month for another 24 months. Seems great, but that’s only going to be GBP 504,201.68 at this new exchange rate. So, I need to fight for a 6% price increase just to stay steady with the figures from our last contract or I realize revenue contraction from a happy customer. ;( Again, multiply that by 50 European customers and I’ve got a material renewal problem to deal with. We love this sh*t, so you don’t have to 😉 These are the types of problems that Bound helps SAAS-companies deal with. Reach out to see if you can make your foreign cash flows more stable and predictable. Recommended Reading Join our Treasury Community Treasury Masterminds is a community of professionals working in treasury management or those interested in learning more about various topics related to treasury management, including cash management, foreign exchange management, and payments. To register and connect with Treasury professionals, click [HERE] or fill out the form below.
Franklin
Treasury and Fintech: Collaborating for Innovation and Automation
In our dynamic finance space, Treasury departments are increasingly looking to fintech companies to drive innovation and enhance financial processes. This collaboration is not just a trend but a strategic necessity, as it offers numerous benefits, including improved efficiency, enhanced risk management, and better customer experiences. Here, we explore how Treasury departments can effectively collaborate with fintech companies, drawing on relevant examples and references. The need for collaboration Treasury departments have traditionally been seen as back-office functions focused on managing cash flow, liquidity, and financial risk. However, the role of treasury is evolving. Modern treasury departments are now expected to provide strategic insights and drive value across the organization. This shift requires advanced technology and innovative solutions, which fintech companies are well-positioned to provide1. Benefits of collaboration Examples of successful collaborations Key considerations for collaboration Conclusion The collaboration between treasury departments and fintech companies is a powerful driver of innovation in the financial sector. By leveraging fintech solutions, treasury departments can enhance efficiency, improve risk management, and offer better customer experiences. As the financial environment continues to evolve, these collaborations will become increasingly important for achieving strategic goals and maintaining a competitive edge. Recommended Reading Join our Treasury Community Treasury Mastermind is a community of professionals working in treasury management or those interested in learning more about various topics related to treasury management, including cash management, foreign exchange management, and payments. To register and connect with Treasury professionals, click [HERE] or fill out the form below to get more information. Notice: JavaScript is required for this content.
Jessica
Natural Hedging Vs. Financial Hedging: Navigating Currency Volatility
This article is written by GPS Capital Markets When we talk about managing currency risk, two approaches often come up: natural hedging and financial hedging. At their foundation, they are two different strategies for tackling the same problem: protecting your business from fluctuating exchange rates. Here we’ll break them down, using some real-world scenarios to help illustrate how companies deal with this challenge. Whether you’re running a multinational or a small business expanding overseas, understanding these tools is crucial to managing your bottom line. What is Natural Hedging? In simple terms, natural hedging is when businesses adjust their operations to minimize exposure to currency fluctuations naturally. In one example, a US-based company with substantial European sales might opt to open production facilities in Europe. By earning and spending in the same currency, the business reduces the impact of exchange rate volatility. In another example, a US clothing manufacturer sells heavily in the Eurozone. Instead of producing everything in the US and dealing with perpetual USD-to-EUR exchange risk, they open a factory in Germany. Now, they can pay their local employees and suppliers in euros while also receiving their sales in euros. This natural hedging strategy shields the company from exchange rate swings between the dollar and the euro, ensuring their costs and revenues are in the same currency. Interestingly, a recent poll we conducted showed that 23% of respondents rely on natural hedging to manage FX volatility. This approach is particularly appealing to companies expanding into new markets and needing to align revenues and expenses in the same currency. How Financial Hedging Works In contrast, financial hedging involves using financial instruments, like forward contracts or options, to lock in exchange rates for future transactions. While natural hedging adjusts business operations, financial hedging focuses on leveraging market tools to mitigate risk. Let’s say there’s a UK-based electronics company that imports components from Japan. They have a large payment of ¥50 million due in six months. Rather than risk potential yen appreciation against the pound (which would make the payment more expensive), the company uses a forward contract to lock in today’s exchange rate. With financial hedging, they secure a fixed exchange rate, ensuring their future payment won’t exceed their budget due to unfavorable currency movements. A recent poll revealed that 54% of companies actively use FX hedging programs, reflecting a clear preference for financial hedging when it comes to managing cash flow in uncertain times. These tools offer flexibility, especially in unpredictable markets. The Federal Reserve’s Role in Hedging Strategies Speaking of market unpredictability and their role in hedging strategies, it’s impossible to ignore the role of central bank policies. A recent poll asked, “How many base points do you think the FOMC will cut at the next meeting?” with 72% predicting a 25-bps cut. However, on September 18, the Federal Reserve surprised markets by cutting rates by 50 bps—something that was not predicted by our LinkedIn audience. This underscores the importance of having an expert with their finger on the pulse to make predictions and revise strategies at a moment’s notice. Using the advanced automated features of FXpert, businesses can also react faster than humans to market changes. FXpert’s ability to monitor markets and lock in trades across time zones far exceeds manual capabilities, providing businesses with an edge in managing currency exposure. The Dollar Index and Hedging Considerations Another factor businesses must consider is the performance of the U.S. dollar. With the Dollar Index trading near 2024 lows, companies relying on natural hedging or financial hedging need to keep a close eye on these trends. A recent poll indicated that 75% of participants expect the Dollar Index to close lower than it did in 2023. A weaker dollar can lead to higher costs for businesses that import goods, making financial hedging a key strategy to safeguard against such volatility. Choosing Between Natural Hedging and Financial Hedging Ultimately, choosing between natural hedging and financial hedging depends on your company’s operations, cash flow, and tolerance for risk. For businesses looking for a long-term operational solution, natural hedging offers a straightforward approach to reducing currency exposure. However, if market conditions or transactions are more fluid, financial hedging provides the flexibility needed to navigate short-term fluctuations effectively. Both strategies have their place, and successful companies often use a combination of natural hedging and financial hedging to optimize their exposure. Whether you’re expanding into a new market or trying to manage ongoing FX risk, understanding both approaches—and leveraging tools like FXpert—can help you make informed decisions and protect your business from unexpected currency swings. The Value of GPS Capital Markets’ Expertise in Financial Hedging When you decide to go the financial hedging route, GPS Capital Markets’ team of experts becomes an invaluable resource. Our experienced advisors not only help you craft a tailored hedging strategy that aligns with your business goals, but they also provide real-time insights into market movements. With access to advanced tools like FXpert, we can help you identify opportunities, lock in favorable rates, and manage trades seamlessly across global markets. Whether you need ongoing support or quick adjustments in volatile situations, GPS offers the expertise, technology, and service that ensure you’re always one step ahead in managing your financial risk. Also Read Join our Treasury Community Treasury Masterminds is a community of professionals working in treasury management or those interested in learning more about various topics related to treasury management, including cash management, foreign exchange management, and payments. To register and connect with Treasury professionals, click [HERE] or fill out the form below to get more information. Notice: JavaScript is required for this content.
Treasury for Non-Treasurers: Crossing the Chasm (Part I)
Introduction We left off last week talking about the ‘The Chasm’ and saying that many treasuries end up in it. We also noted that non-treasury stakeholders won’t get material value-add unless they deal with a treasury that has crossed the chasm. It’s, therefore, worth understanding what it is and how to get out of it. And how non-treasurers can help. This part of ‘Crossing the Chasm’ explains the chasm. We will review practical ways to cross it next week. Who is in the chasm? There is no specific revenue tell for companies in the chasm. A company with $ 250 m revenue with a treasury can be a control-oriented treasury not in the chasm or in a stakeholder-oriented one in the chasm. A multi-billion-dollar revenue company can have a treasury that is anything from control-oriented to value-adding and externally focused, so anything from operational to strategic, outside the chasm, or tactical. Many factors are at play, and we will talk about them here. What causes the chasm? In a few words, it’s amount, culture and context. Amount An organisation with a low turnover doesn’t generate enough cashflows in numbers of transactions and or values. It can’t cost-justify a bigger, more sophisticated treasury. Culture Treasury has a culture. It is within finance, which has a different culture. That’s within a company with yet another culture. Other functions with different cultures surround it, some more important than others, such as procurement in a company with large purchasing requirements or HR in one looking after talented and rare employees. Plus, any of these can have dominant individuals within them with their own background cultures and personalities. Geographical aspects of culture Consider the following: If a company is headquartered and senior management is in and from a risk-averse culture, are the board and C-suite likely to allow the treasury to cross the chasm and start taking financial risks? Even in a case where the CFO and Treasurer are from low-risk-aversion cultures? It’s not likely. Nor if it’s the other way round. A high-risk-aversion treasurer will not support crossing the chasm no matter if the CFO or board might be open to it. So, to bridge the chasm, what’s needed is a major culture change. And that’s something no treasurer I’ve met is trained to lead. However, that training, or support from people with that training, is exactly what’s needed if a company wants to cross the chasm and go from being operational and tactical to strategic. “What gets measured gets managed”, Peter Drucker. This is an excellent time to say that cultural factors, including risk aversion, have been quantified and can be compared to each other in a culture change program. See Image 1 below. Quantification allows culture change planners to be more exact in how to structure successful culture-change programs, so this information is invaluable: Organisational Culture Culture is not all about nationality. It’s about organisational culture as well. And let’s not reinvent the wheel here. We’ll use the ‘Iceberg Model of Culture’ created by Edward T Hall in 1976 and shown in Image 2: Again, these conscious and unconscious cultural aspects are different at organisation, finance function, treasury itself, and for all other material stakeholder functions. It’s complex. But, “What gets measured gets managed” again: Quantitative ways to measure corporate culture exist. The best known, now over 40 years old, is the ‘Competing Values Framework’ by Quinn and Rohrbaugh. In the interests of brevity, I won’t get into it here, but please get in touch if you want more details. Simplifying and Concentrating on the Key Elements of Culture Clearly, there’s too much to analyse to decide whether and how to change in a practical way. So, although we should remember the big picture for any individual company, we can simplify. I have found from my work that, in most instances, the following are most important: 1. The geographical culture of the company 2. The geographical culture of the essential stakeholder functions 3. The geographical culture of the key personalities, which, for treasury, always includes but is not exclusive to the CFO and Treasurer 4. How each external partner (you, the non-Treasurers) perceives time compared to treasurers (more on this in a moment) 5. How each external partner uses language (again, more on this in a moment) 6. The organisational structures in both treasury and the partner functions 7. The KPIs and bonus systems The first three are easy to understand from the paragraphs above. The following three, though, are thought-provoking: Time perception: The easiest way to describe this is by providing an example. Accounting, FP&A, and tax get, analyse and use information at month-, quarter-, and year-end. This is so normal that it’s taken for granted. It’s embedded in the core values of the finance functions. On the other hand, treasury works with financial markets, where rates move constantly. Their perception of time, embedded in their core values, is different. As a result of the differences in perceptions about time, accounting has problems understanding why waiting for information relating to cashflows to be added to systems at a convenient time within the month is a problem for treasury, who need it as soon as possible. The same is true with errors that will, in their minds, be corrected at month- or quarter-end or even after. It’s not a problem for the rest of finance, why is it for treasury? This time perception difference causes tension and prevents them working together to evolve from tactical to strategic. Other functions have their own embedded, unconscious perceptions of time. The more functions there are, the more difficult it is to achieve mutual understanding. But, it’s vital to understand there’s no malice between departments not being aligned or moving not fast enough or too fast. Each function must understand the time perception of the other and what’s important to each, to optimise how they work together. Language: The use of language is also a subconscious, deeply embedded part of cultures and subcultures. Using the…
Deciphering Bank Analysis Statements: The AFP Service Codes
Transparency is critical in any relationship. Unfortunately, there is a long-standing inherent barrier to transparency in every relationship between a bank and a client, the bank analysis statement. Understanding the majority, let alone all of the charges depicted on a bank analysis statement, is difficult at best. I have personal experience with the challenges of understanding bank analysis statements. It took me months and more than one in-person meeting with a group of employees with a bank partner to understand the charges on their monthly bank analysis statements. Deciphering bank analysis statements became a regular part of my routine. I spent hours each month reviewing bank analysis statements and I often found billing errors. I know that Treasury professionals still face these same challenges. The format and structure of a bank analysis statement are far from consistent across different banks, and the structure of fees and verbiage on the statements for most banks change over time. The good news is that there are resources and technology that can help companies understand and banks deliver transparency in bank analysis statements. AFP Service Codes and Global Service Codes The Association for Financial Professionals (AFP) created and manage the AFP Service Codes©, which have served as the industry standard codes assigned by all major banks to their cash management services billed to companies since 1986. The AFP Global Service Codes© were created in 2011. The global codes were designed specifically for the international community. Unfortunately, many banks still do not leverage the AFP Service Codes© and/or the AFP Global Service Codes© on their bank analysis statements. Even if a bank leverages both code sets and assigns them correctly, the volume of bank statements and services consumed still makes benchmarking and managing bank fees from even a single bank cumbersome. Proper assignment of the codes by banks on bank analysis statements would allow Treasury professionals to perform analytics, cross-bank comparisons, and manage bank fees effectively. Bridging the Gap in Code Utilisation Unfortunately, most Treasury professionals do not even know that both code sets exist, let alone how to leverage them to benchmark and manage bank fees. Companies should collaborate with banks in understanding each line in a bank fee analysis statement and look to them to help in assigning services to the right AFP Service Codes© and/or on AFP Global Service Codes©. Some banks offer AFP Service Codes© and/or on AFP Global Service Codes© on analysis statements for categories of fees, but these codes can still be assigned incorrectly. There have been recent updates to the AFP Service Codes and the AFP Global Service Codes. An update was done to the AFP Service Codes© in 2020 and left only 32% of the existing codes unchanged, and an update to the AFP Global Service Codes© in 2023 modified or added half of the codes in this release. Even before these comprehensive code updates, it was not uncommon for banks that attempt to use either set of service codes to assign more than 40% of them incorrectly. Therefore, the potential for the misassignment of codes by banks on analysis statements and the challenges of understanding and benchmarking bank fees has become greater for treasury professionals over the past few years. The Future of Bank Fee Management The good news is that there are bank fee analysis solutions that give users access to an unprecedented range of datasets to help them evaluate and benchmark the costs of their banking operations across the globe. This empowers companies to identify inefficiencies, eliminate redundancies, and benchmark and manage bank services while removing an inherent barrier to bank relationship management success, a lack of pricing transparency. Companies need to understand what they are being charged by a bank partner to determine the value of that bank partner. Deciphering bank analysis statements is crucial in this process. Also Read Join our Treasury Community Treasury Masterminds is a community of professionals working in treasury management or those interested in learning more about various topics related to treasury management, including cash management, foreign exchange management, and payments. To register and connect with Treasury professionals, click [HERE] or fill out the form below. Notice: JavaScript is required for this content.
Ernie Humphrey