The treasury function

A large group has dozens of bank accounts. One subsidiary sits on idle cash while another pays overdraft interest. A supplier in the United States must be paid in dollars in three months, and the naira may fall before then. Someone has to see all of this at once and act on it. In a large organisation that someone is the treasury department.

This topic covers what treasury does, how it manages cash, how it raises long-term and short-term finance, the main financial risks it handles, the risks inside treasury itself, and whether treasury should be a cost centre or a profit centre. The previous topic covered financial strategy and objectives. The next topic covers stakeholders, corporate social responsibility and ethics. Hedging with derivatives has its own later topics. Past papers have asked about treasury financing strategy and short-term investment.

Key terms in plain English

Syllabus check

This topic links syllabus area A (financial strategy and the management of resources) and area G1, the role of the treasury function in:

• the short-term management of financial resources;
• the longer-term maximisation of corporate value;
• the management of risk exposure.

CAMA 2020 and the treasury

The Companies and Allied Matters Act 2020 (CAMA 2020) is the company law of Nigeria.

The role of treasury

The central treasury must see that cash is available in the right amounts, at the right time and in the right place. To do this it:

• produces regular cash flow forecasts to predict surpluses and shortfalls;
• arranges short-term borrowing and investment;
• deals with the banks and arranges day-to-day facilities;
• advises senior management on long-term financing;
• buys foreign currency when needed and sells foreign currency receipts;
• protects the business against adverse movements in exchange rates and interest rates.

Cash forecasting and cash management

A company needs enough cash, or access to borrowing, to meet its payments. Short-term forecasts use receipts and payments budgets. Longer-term forecasts use an expected cash flow statement. If a deficit is forecast the treasury can ask the bank for more finance, defer spending or speed up receipts. If a surplus is forecast it decides how long the surplus will last and how to invest it safely for that period.

Large companies find it easier than small ones to borrow and to invest.

A central treasury can manage the group position. With pooling, the balances in the group’s accounts in one currency are moved each day into a central account. Deficits and surpluses are netted, so the group avoids interest on overdrawn accounts while other accounts hold idle cash.

Advantages of a central treasury

• Specialist staff run cash more efficiently.
• Pooling channels cash to where it is needed and cuts overdraft interest.
• The group needs less precautionary cash than all its units would hold separately.
• One large buyer of banking services has more bargaining power.

Financing long-term and short-term needs

Long-term investment needs long-term finance, either equity or debt. Bank loans count as long-term if fixed or revolving for several years, though they are typically up to about seven years. Inventory and receivables are financed by a mix of long-term finance and short-term liabilities such as trade payables.

• Equity: mostly retained profit. New shares for cash are hard for a small unlisted company. A listed company needs the support of the market, and in some countries must offer the shares to existing holders first. In a takeover, target shareholders may be offered shares in the bidder. Venture capital can fund an unlisted company.
• Debt: mainly bank loans. Large companies can issue bonds.
• Trade finance: treasury may arrange finance for foreign trade.

Short-term finance

Most short-term finance is trade credit and bank lending. Large companies also use:

• Commercial paper: unsecured short-term debt with a maturity of 270 days (nine months) or less, sold in large denominations at a discount to par and redeemed at par. The difference is the interest. Only companies with excellent credit ratings can issue it at a reasonable price.
• Bankers’ acceptances: a time draft issued by a company (the drawer) and guaranteed by a bank, with maturities of 30 to 180 days. The bank must pay the stated amount at maturity. The holder can keep it or sell it at a discount, which shrinks as maturity nears. It helps trade between parties with no credit history. To the drawer it is like a post-dated cheque.

Financial risk management

Treasury is usually responsible for managing financial risk:

• Foreign exchange risk and interest rate risk, covered in later topics.
• Credit risk: that a debt will not be paid or will be late. Credit control is part of day-to-day finance. Treasury also watches the company’s own credit rating, because banks charge a higher spread over the risk-free rate to lower-rated borrowers and the interest on new bonds depends on the rating.
• Market risk: that the price of shares or bonds held as assets will fall.

Risks of running a treasury

• Finance may be raised inefficiently: interest higher than needed, the wrong mix of short and long-term debt, or the wrong balance of debt and equity, which raises the cost of capital.
• Risks may be under-managed, for example too little use of forward contracts or swaps.
• Dealers may exceed limits, make dealing errors (buying instead of selling, wrong price or quantity) or fail to record deals.
• Surplus funds may earn only a low return.

Cost centre or profit centre

As a profit centre, treasury deals with business units at market-based prices. Advantages: a chance of extra profit; motivation to be efficient; realistic transfer costs. Disadvantages: possible huge losses from speculative deals; extra administration; and management time spent negotiating transfer prices.

The rules in more depth

Why pooling saves money

Overdraft rates are higher than deposit rates. If one unit borrows at 22% while another deposits at 9%, the group loses the gap. Pooling removes the overdraft and earns the deposit rate only on the net surplus.

Why only strong companies issue commercial paper

It is unsecured. Lenders have only the strength of the borrower to rely on, so a company with a weak rating cannot sell it at a reasonable price, if at all.

Why a profit centre can be dangerous

A treasury that is rewarded for profit has an incentive to speculate. Strict limits, separation of dealing from recording, and audit committee review are the usual controls.

Effect on analysis

When you advise on treasury in a scenario, link the proposal to the facts: size of group, currencies, credit rating, interest rate view and cash pattern.

Worked examples

1. Without pooling.
   overdraft interest = (35 + 15) × 22% = ₦11.0m.
   Deposit income = (60 + 20) × 9% = ₦7.2m.
   Net cost = ₦3.8m.
2. With pooling.
   net surplus = 80 − 50 = ₦30m.
   Income = 30 × 9% = ₦2.7m.
3. Annual benefit.
   3.8 + 2.7 = ₦6.5m.

1. Interest on the paper.
   200 − 194 = ₦6.0m.
2. Return for 90 days = 6 ÷ 194 = 3.09%.
   Annualised = 3.09% × 365 ÷ 90 = 12.5%.
3. Overdraft cost.
   200 × 22% × 90 ÷ 365 = ₦10.85m.
4. Saving = 10.85 − 6.0 = ₦4.85m, if the company has the credit rating to issue the paper and ignoring issue costs.

1. The acceptance promises $500,000 to the holder in three months.
2. The bank guarantee removes most of the non-payment risk for the supplier.
3. The supplier can hold it to maturity or sell it at a discount, which falls as maturity approaches.
4. At maturity the accepting bank pays $500,000 and takes the money from X’s account.

How to score full marks

• Link each point to the scenario: size, currencies, rating, cash pattern.
• Give both sides for centralisation and for the profit centre decision.
• Show calculations for pooling and for the cost of short-term finance.
• Use the right term: pooling, netting, precautionary cash.
• Name the controls for treasury risk: limits, segregation of duties, reporting and audit.
• Answer the question asked, not everything you know about sources of finance.

Common mistakes in the exam

• Listing every source of finance when the question asks about a specific strategy.
• Confusing commercial paper (issued by the company, unsecured) with a banker’s acceptance (bank guaranteed).
• Forgetting that only highly rated companies issue commercial paper.
• Ignoring the days when annualising a discount.
• Calling pooling a transfer of ownership of cash between companies without noting legal limits.
• Missing the risks of the treasury itself.

Quick revision

• Treasury: cash in the right amount, time and place; short-term resources; long-term value; risk.
• Pooling and netting cut interest and precautionary cash.
• Commercial paper: unsecured, 270 days or less, discount. Banker’s acceptance: bank guaranteed, 30 to 180 days.
• Risks managed: foreign exchange, interest rate, credit, market.
• Treasury risks: poor financing, weak risk management, dealer error, low returns.
• CAMA 2020: ss. 374(1), 377(1), 378, 308, 404(7).

Practice questions

These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer. Full model answers follow the written questions.

Recall check: multiple choice

The real ICAN paper has no multiple-choice section. These questions are for quick recall. The written questions that follow are closer to the exam.

Written questions

Model answers

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