Reorganizing Cash Management and Foreign Exchange in an Industrial Company

Regula Spottl, Tomato Treasury, Cash and Risk Management, 21 Jul 2000

Most bankers pursue careers in the traditional banking industry. The few who venture into the treasury departments of a small or mid-size industrial corporation often return to banking because of the different working culture within the industry and the requirement to do accounting, statistics, quality control and other tasks that have little to do with banking.

Individuals in treasury departments of corporations often have a thorough knowledge of the industry but limited banking expertise. Consequently, they tend to run a level of risk based on their limited knowledge and experience level, passing up opportunities to optimize liquidity and forming a strategy for the use of derivative products and electronic optimizers such as treasury software that may lack sophistication.

This case study illustrates how a corporate treasury consultant can help establish a daily business action plan that is easy to implement and lasting in its effect.

The consultant in this case has

• a banking education
• more than 15 years of front office contact and negotiation skills with corporations
• more than ten years of experience in trading with money market, foreign exchange market, and bond market instruments
• knowledge of how to clear and handle these instruments from an operational point of view
• ability to bolster cooperation and a new way of doing things among departmental staff

The client in Basel, Switzerland, is a mid-size family-owned business that specializes in the international trade of raw materials, intermediates and additives for the pharmaceutical industry.

A certified accountant along with three business administrators heads their treasury department. None has a level of expertise or experience that would qualify them to make banking choices; and they are unable/not used to negotiating favorable terms with banks as a banker can.

The client's foreign exchange operations has the following currency structure:

• 60% of sales are conducted in CHF and, therefore, do not pose a direct currency risk
• 23% of sales are invoiced in Euro
• 15% of sales are invoiced in U.S. dollars
• 2% of sales are invoiced in various other currencies

The client was working with eleven bank accounts in Switzerland, Austria, and Germany with non-interest bearing checking accounts and high interest line of credit accounts (over 10%).

After three days of research and strategy discussions, the consultant presented a proposal for streamlining the daily, weekly and monthly cash and foreign exchange procedures and basic introduction into derivatives. The proposal promised to

• reduce costs of bank accounts and bank liabilities
• add an opportunity profit maker with the use options
• cut down time needed to manage accounts by using standard procedures for the routine business
• eliminate the need for new treasury software

Taking advantage of daily dispositions of their bank accounts and establishing a netting system with their activities in Austria and Germany promised to result in significant savings.

Specifically, the project included

Introducing hedging together with a streamlined process for the use of banking transactions as a means to limit the risk/take advantage of currency fluctuations. Specifically, the consultant suggested:

Macrohedging

• Netting of the required foreign currency for imports, i.e. allocating incoming foreign currencies of exports during a specific time period. To analyze and control these processes, the consultant examined history data of exchange flows and total import and export of the last five years.
• Making single purchases or sales of foreign currency for changes in fixed assets that are to be activated or deactivated and that are critical for the balance sheet from a fixed currency account. This also functions as a basis for potential depreciation.

Microhedging

• Hedges against the current assets for large single transactions of goods for the purpose of securing an exchange rate guarantee and allocation of exchange rate for a single profitability analysis.
• Hedges against fixed assets for the purpose of allocating a fixed exchange rate for deposits or withdrawals from fixed assets, as well as the determination of value for the purpose of depreciation and tax reporting.
• For investments in fixed assets that incur staggered payments.

Specifying Time Frames

For foreign currency purchases and sales, the consultant suggested a time frame of six months. While straightforward foreign exchange contracts of more than six months are possible, they lock in prices for export markets which can result in loss of revenues or market share.

For money market transactions the consultancy suggested to reduce the maturity of time and term loans taken by Swiss banks from three or four maturities per year down to one per month. This gives the flexibility to use seasonal liquidity and money from outstanding liabilities for those payments which can be can be paid later based on contracts conditions in order to reduce these bank liabilities.

Bank relations

a) Terms and Professionalism

Establish foreign exchange and cash management contacts and limits with at least two banks. Formulate a list of conditions for standard services such as foreign exchange swaps, time deposits, or call money placements, and for the purchase of options on foreign exchange.

The consultant assisted in a meeting with one of the banks. The banker and his forex team were asked to assist in their customer's learning process. New conditions on bank account debit and credit interest were negotiated. Needless to say, the bank representative was at first not very receptive since, initially, it meant loss of revenues. Nevertheless, the bank gained a new type of relationship with a customer capable of professionally handling his business.

Furthermore, the customer is less intimidated and receptive for new bank products and becomes a real partner with the banker. It was obvious that the banker realized this as well as he offered a better bid.

b) Closing Bank Accounts

Reducing the number of U.S. dollar and Euro accounts from 11 down to 4 accounts at banks in Switzerland, one in Austria and one in Germany. Five bank accounts were either closed, or are maintained for the sole purpose of paying taxes. As result, the daily cash-report immediately improved in quality and it continues to help saving time to execute bank and account transfers.

Operation Manuals

All daily, weekly, monthly, quarterly, and semi-annual actions/procedures are written down in a dealer and operational manual. These formal documents serve not only the individuals presently working in the department, but also as introductory reference manuals for new personnel as well as for individuals outside the department who may need the information.

A trading and risk guide was outlined and written and then approved by the board of directors.

Coaching

The client immediately started to work with these for him brand-new processes. One month later, the consultant met with the client team to answer questions and review progress. In three to four month, the consultant will again meet with the client team to review the process and progress reports. This will then allow for

a) the client himself to offer changes

b) the consultant to verify that no details have been missed or to detect points that may be fine-tuned.

The net effect for the client is that the time needed for conducting day-to-day business is drastically reduced since they now use standard practices and procedures for daily operations. Charges on term loans have been reduced by up to 30%. The interest paid on overdrawn accounts has been brought down to zero.

The project involved twelve days of research, discussions with staff and negotiations with banks, preparation of documentation, and education of department personnel. For the client, it was a short and painless exercise that reaped financial benefits and heightened the level of motivation of personnel.

In addition, the money saved after streamlining the activities based on the consultant's services paid off in less than one month after implementing the new procedures.