Can Treasury Go From Support to Strategic Function? with Dr Kurt Smith
Welcome to an enlightening journey into the world of corporate treasury. Imagine yourself as a wizard of finance, weaving spells to help businesses grow and thrive. That’s a fun way to think about treasury professionals, right? They’re the magicians behind the scenes, ensuring companies have the money they need to achieve their dreams. But did you know that the role of corporate treasurer is evolving, becoming even more important in today’s business world?
We have Kurt Smith on board, brought to you by TreasuryXL, to guide us through this intriguing transformation. With an impressive career portfolio, Kurt is the Director of Marengo Capital and Vice President and Technical Director of the Australian Corporate Treasury Association (ACTA). His wealth of experience encompasses everything from being a Head of Derivative Trading in banking to strategic asset allocation in fund management, and corporate treasury.
Here’s what we’ll be learning today:
- What Risk Appetite and Risk Strategy Truly Means for Corporate Treasury and The Board of Directors.
- How Could Treasury Be Much More Strategic Rather Than Focusing Only on Operational Tasks?
- What Metrics, Such as The Return on Invested Capital, Cash Conversion Cycle and Weighted Average Cost of Capital Are?
- How Could Treasurers Influence Those?
- And The Role of The Australian Corporate Treasury Association
- And Much, Much More.
So, are you ready to discover how treasury professionals are stepping up their game and using cool technologies like artificial intelligence to become strategic powerhouses? Are you excited about how they’re moving from simply supporting businesses to actively shaping their future? Let’s dive in!
Understanding the Key Roles of Treasury Departments
Hussam starts the discussion by asking Kurt Smith about the primary responsibilities of treasury departments. With his wide-ranging experience in the financial sector, Kurt delves into the key roles of a treasury department.
Main Functions of a Treasury Department:
- Cash and liquidity management
- Funding and refinancing
- Financial risk management
- Operational risk management
Kurt notes that most treasury departments are mainly focused on financial risk management. This role can be interpreted in many ways, from a narrow understanding of traditional tasks to a broader view encompassing more strategic activities.
The Shift from Operational to Strategic Treasury
Although many treasurers excel in operational treasury, Kurt highlights an important distinction between the operational and strategic aspects of the role. He insists that stopping at operational treasury means leaving substantial value unclaimed.
Operational treasury vs Strategic treasury:
- Operational treasury: Focused on daily tasks, functions, and transactions
- Strategic treasury: Takes a broader view of the role of Corporate treasurer, aiming to bring additional value to the company and transform the department from a support function to a strategic partner
Changing Perceptions: From Cost Center to Strategic Value-Add
In discussing how the rest of the company views the treasury department, Kurt confirms the common perception of it as a support function. However, he advocates for a shift in this mindset. Instead of viewing the department as a “cost centre,” Kurt suggests that the treasury should be seen as a “centre of strategic value-add.”
By adopting this viewpoint, the treasury department operates more like a business, aiming to add value that covers its operational costs at the very least. This transformation from being a cost centre to a value-adding entity enhances the department’s role within the company and provides a more rewarding and engaging environment for treasury professionals.
Understanding Risk Appetite in Treasury
Guillaume brings up an important topic of conversation, asking Kurt to explain what risk appetite is. Kurt responds, describing risk appetite as a measure set by a company’s board. It defines which risks the company will take and which it would rather avoid.
What is Risk Appetite?
Risk appetite is a term that means how much risk a company is ready to accept. It’s like when you’re playing a game and decide how much you want to risk to win. In a company, the board (the people who make the big decisions) decide this. They choose which risks they’re okay with and which they don’t want to take. This is done for the whole company, and each part of the business follows this.
Kurt explains that treasury departments can influence this risk appetite by developing an effective capital management strategy. The capital management strategy includes sourcing capital from capital markets and financial institutions, structuring capital between debt, hybrids and equity to lower the cost of capital, and allocating capital to projects, M&A etc. to generate a return on invested capital which is value-accretive.
Capital Allocation in Treasury
Capital allocation is how a company decides to use its money. It’s like when you get your allowance and decide how much to save, spend, and where to spend it. In a company, the treasurer often helps decide this.
Kurt notes that for treasury to be influential they must be involved at the start of the value chain. This way, they can provide advice on the current cost of capital in the market, which informs the level of return on invested capital that is required to generate value and may have an impact on corporate design (central funding, project finance, capital structure, etc.). Being involved at the end of the value chain simply to source capital, may result in funding being raised in the market at levels where the project is not value accretive.
The Role of Risk in the Treasury
Guillaume follows up by asking how risk appetite is decided. Kurt explains that some people believe the role of Corporate treasury is to minimize risk. However, he says this is a misunderstanding. Companies are actually looking to take on risk – they want it to be the right kind of risk that will provide the required return on their investment.
Misconceptions About Risk
Kurt explains that some people think the treasury’s job is to eliminate risk. But he says that’s not right. Companies know that conducting business is inherently risky. They just want to choose the right risks to take – which is governed by the Board’s risk appetite and the levels of return they earn on the allocated capital.
Finally, Kurt emphasizes that the role of corporate treasury should not just be about day-to-day tasks. It’s about looking at the bigger picture and figuring out how to add value to the business. This is the difference between being focused on operations and being strategic. Being strategic means thinking about the long-term and enterprise-wide, to determine how the treasury can help the business grow.
Kurt’s explanation gives a comprehensive view of the role of corporate treasury in risk management and capital allocation. It also underscores the need for treasury departments to play a strategic role in their organizations. This perspective helps treasury professionals understand their role better and contribute effectively to their company’s growth.
The Gaps Between a Company’s Risk Appetite and Actual Risk Mitigation by Treasury Departments
Guillaume and Kurt Smith discuss gaps between a company’s risk appetite (how much risk a company is willing to accept to reach its goals) and what treasury departments are doing to manage risk. They both agree that such gaps often exist due to a fundamental misalignment – risk appetite is enterprise-wide and cascades from the top-down through the business, whereas treasury’s often focus transactionally from the bottom-up.
Kurt explains that companies must have a strong operational treasury foundation before they can be ambitious strategically. He emphasizes that maintaining the board’s trust is crucial for any strategic approach, and treasury departments which report compliance breaches and other operational failings could potentially jeopardize this trust.
Kurt also mentions that people usually “fall into treasury” rather than plan a career in it from the start. They use their very strong technical skills to ascend the ranks, but as they become more senior, the operational side of the business and the C-suite and board require individuals who can explain complex concepts effectively. In other words, they need a technically astute professional with strong commercial acumen, not a treasury technocrat.
Enterprise Value and Enterprise Risk as Key Performance Indicators (KPIs)
Guillaume next asks Kurt about the ranking of enterprise value (the total value of a company) and enterprise risk (the potential threats to a company’s ability to achieve its business goals) in terms of KPIs. He also questions whether financial risk is one of the significant enterprise risks.
Kurt underscores the importance of KPIs in focusing people’s minds. He emphasizes that if the treasury department can demonstrate how they help build enterprise value and reduce enterprise risk, they provide a compelling case for their role and importance in the company. They effectively assist the board and the C-suite in meeting their KPIs, earning a “seat at the table”.
According to Kurt, financial risk is one of the biggest enterprise risks. The financial markets’ volatility and the large volumes dealt within the treasury department mean that value changes can be significant. If not managed properly, these changes can result in a decrease in the capital funding capacity of the company, which in turn reduces the investment opportunities the company can exploit.
Transforming Treasury from a Cost Center to a Centre of Strategic Value-Add
Guillaume asks Kurt how to transform a treasury department from a cost centre (a department that incurs costs and doesn’t directly generate value) into a centre of value-add (a department that contributes directly to increasing value).
Kurt explains that understanding how value is created is crucial for this transition. He identifies two ways to create value – increasing cash flow and reducing the cost of capital, both of which fall under the treasury’s responsibilities. Kurt suggests that most treasury’s forecast cash as part of their liquidity management, but few use their unique knowledge of the flow of cash throughout the company to target increasing cash to add value.
He shares an example of how he showcased to a CFO the wastage in the company, such as unused floors and paper stacks, which could be reduced to save cash. He emphasizes that every employee, not just those in treasury, needs to understand what drives value, as value is often achieved through the accumulation of little things.
Kurt further mentions that operational people might not always understand what “value” means, recalling a misunderstanding with an engineer who thought Kurt wanted to sell the company when he talked about “value.” He clarifies that increasing value means growing the capital base, which allows funding for more projects.
Finally, Kurt talks about the importance of communication and understanding the business. He advises treasury professionals to meet with people in the business to understand its workings better. As a KPI, he insists his team members meet with people in the business to understand its operations better. This proactive approach to understanding the business and its needs is crucial in transforming the treasury department into a centre of strategic value add.
Understanding the Concept of Return on Invested Capital (ROIC) and Its Optimization by Treasury Departments
Return on Invested Capital, or ROIC, is a performance measure determining how efficiently a company uses its capital to generate profits. In simpler terms, it shows how good a company is at turning its investments into profits.
In an interview with Kurt Smith, he breaks down the ROIC formula in plain language: it’s your business’s net operating profit after tax divided by invested capital. The profit part refers to your earnings before interest after applying a “notional” (or theoretical) tax to ensure the deductibility of interest basis is aligned between the return on, and cost of, capital. The invested capital part refers to the sum of operating working capital and net property, plant and equipment.
Why is ROIC Important?
This measure is crucial because it helps businesses understand whether their returns exceed the cost of their capital (the money they need to run the business). This is necessary for a business to grow in value. It’s like ensuring that what you earn from selling a product is more than what it costs you to make it.
Additionally, your return should match the level of risk you’re taking. This is a principle of efficient use of resources. You should expect a big return if you’re taking a big risk.
How Can Treasury Departments Optimize ROIC?
Now, how can treasury professionals help their businesses optimize ROIC? Increasing ROIC effectively boils down to increasing cash, making the best use of your operating working capital (the money you use for daily operations) and allocating capital to efficient investments.
When considering your cost of capital (the money you need to run your business), there are several things you need to do. The objective is to reduce the cost of capital so that more investments will be value accretive (i.e. returns will exceed the cost of capital). If your company has a credit rating, you want to make your earnings less volatile (or unstable) to improve your rating, as this provides a step-change reduction in the cost of capital.
You also need to pay attention to your credit rating triggers that might lead to a rating downgrade. Similarly, you have to pay close attention to banking agreement covenants to ensure there is headroom to prevent lock-ups or other negative consequences.
All this involves financial risk management – managing financial risks wisely to ensure that the company is resilient to business cycle downturns and adverse economic events. This goes beyond managing individual transactions to take a broader view of your company’s financial health.
Centralization: A Strategy to Influence ROIC
Hussam and Kurt agreed on a strategy that treasury departments can use to influence ROIC. This strategy is about centralization, releasing cash locked in a Group by pooling and then re-allocating cash between companies through intercompany loans.
The idea is to identify companies in a Group with excess cash and others with a cash shortage. The treasury department can then manage cash between these companies, using surpluses to fund or partially fund shortages. This way, the Group reduces the size and frequency with which it has to borrow money externally.
This strategic approach allows the Group to negotiate better terms with counterparties, and also avoid a situation where one company within the Group is borrowing externally at the same time another is investing externally.
So, to sum it up: by paying close attention to your company’s cash flow, profits, and risks and strategically managing your resources, you can help your company optimize its ROIC and grow its value.
How Can Treasurers Optimize Cash Management and Cash Flow Forecasting?
In this section, Kurt Smith discusses various ways treasury professionals can maximize their cash flow and improve their cash management strategies.
Understanding Cash Flow
Forecasting cash is a core function of every treasury. To forecast accurately requires a wide network within all areas of the business, to provide the information required to minimize variances – in both quantum and timing. Instead of just forecasting cash flow, Kurt emphasizes leveraging the same network and activity to grow cash as that is a key factor for increasing value. One way to do this is by examining the operating working capital, which includes cash balances.
Optimizing the Cash Conversion Cycle
The cash conversion cycle comprises days sales outstanding, days inventory outstanding, and days payable outstanding. By optimizing this cycle, treasurers can leverage a relatively cheap form of internal funding. However, after the COVID-19 pandemic, managing this cycle has become more nuanced, involving supporting key suppliers by paying them promptly or even early to ensure supply.
Balancing Cash Flows
When managing cash, there are two main aspects to consider: the balance and the flow. The balance should reflect a healthy amount of liquidity without becoming a ‘lazy’ balance sheet with too much idle cash. As for the flow, Kurt believes it’s essential to go beyond forecasting and actively look for ways to increase cash flow.
Collaboration with Operations
According to Kurt, the key to increasing cash flow lies in collaborating with the operational side of the business. By understanding the operations and their pain points, treasurers can identify ways to add value and optimize cash flow. This might involve negotiating with regulators, innovating new approaches, or challenging traditional methods that are no longer efficient.
Challenge the Status Quo
Kurt encourages treasury professionals to challenge existing norms and regulations. Even when people claim something can’t be done, there may be opportunities for improvement. For instance, he shared an experience where his team worked with a regulatory body to change how regulated revenue was calculated, resulting in a billion dollars worth of cash being brought forward into a period of tight cash. Kurt’s experience with regulatory economists has shown him there’s room for constructive conversations. As long as the discussions are evidence-based, regulators can be receptive and open to reasonable changes.
Always Prioritize Efficiency
Even minor tweaks to cash management practices, such as managing liquidity tightly by paying down debt, can accumulate over time to substantial savings. Kurt argues that even seemingly small amounts for large companies, like $100,000, should not be dismissed for administrative ease. Instead, the focus should always be on optimizing economic outcomes to add value.
In conclusion, treasurers can significantly influence cash flow and cash management by getting involved at the beginning of the value chain, understanding the operations, challenging the status quo, and actively seeking opportunities to optimize the cash conversion cycle.
How Does the Cash Conversion Cycle Relate to Working Capital Management and Influence Profit and Asset Capital?
Simply put, the cash conversion cycle is like a big clock that starts ticking when a company spends money (say, to make a product) and stops when they get that money back (like when a customer pays). The faster this cycle moves, the less time money is tied up in the process and the more cash the company has. This is why Treasury departments pay a lot of attention to it.
Kurt Smith explains that working capital, which includes cash, accounts receivable (money owed to a company), and accounts payable (money a company owes), is extremely important, especially for fast-growing companies. These companies often have tight working capital, so they need to manage their money well.
When a company manages its working capital effectively, it can use the money it owes (its payables) to fund what it’s owed (its receivables). This way, a company can create its capital internally.
Managing Working Capital
To manage working capital well, a company must be clever and aware. It needs to know how much money it uses (its cash burn rate) and what’s affecting its working capital. For example, if a big customer isn’t paying on time, this can slow down the cash conversion cycle and leave the company short of cash.
Treasurers can help here by talking to the treasurer of the other company. They can ask for payments on time or negotiate payment terms. They can also look into their company’s operations to see if there are ways to speed up the cash conversion cycle.
For example, a simple way to speed things up is to send out invoices as soon as possible after work is completed. Any delays in sending out invoices mean a delay in getting paid, slowing down the cash conversion cycle.
Working with Other Teams to Optimize Working Capital
It’s not just the treasury department that can help optimize working capital. Kurt suggests that teams across the company, like those handling purchasing, logistics, and product life cycles, can also help. If everyone works together to make the company’s operations more efficient, the company can benefit in many ways. For example, it might need to borrow less money and pay less interest.
What is the Key Performance Indicator (KPI) That Treasurers Should Focus On?
According to Kurt, treasurers should focus on and own the weighted average cost of capital (WACC). WACC is a measure of a company’s cost of sourcing money from debt and equity holders. If a company’s return on invested capital (ROIC) is higher than its WACC, it creates value.
Treasurers should also consider how different parts of their company contribute to enterprise-wide risk and return. Business units have different risks and contributions to the company’s profit and loss (P&L). By understanding these differences, treasurers can help allocate the company’s capital more efficiently. This can create a competitive internal market for capital, encouraging business units to develop the best possible projects to generate the highest returns.
All these factors combine to create value for the company, helping to ensure that every dollar spent is put to good use and benefits the company as a whole.
The State of Treasury Departments, and the Role of the Corporate Treasury Association, in Australia
Guillaume asks Kurt Smith about the current state of treasury departments in Australia and how it compares to Europe and the US. Kurt is then asked about his role as Vice President of the Australian Corporate Treasury Association (ACTA) and what the organization does.
The State of Treasury Departments in Australia
Kurt shares that the treasury landscape in Australia is quite diverse. On the one hand, you have large, well-developed treasury departments filled with experienced professionals. On the other hand, smaller companies often have their treasury functions managed by accountants in finance departments. There are many stages between these two extremes.
A common factor across the board, Kurt mentions, is that people who enter the field of treasury don’t often leave it. This leads to a high level of experienced professionals operating at senior levels. However, it also makes it difficult for younger professionals to find opportunities, as they have to wait for senior roles to become vacant.
Australia’s labour market for treasury professionals is tight and competitive. Top talent often commands high salaries. Despite these challenges, Kurt states that Australia’s financial market is quite strong, with a robust rule of law and a very liquid currency.
Kurt also notes that due to their geographic isolation, Australians often embrace independence and innovative thinking, which could sometimes differ from conventional approaches.
Role of the Australian Corporate Treasury Association
Moving on to ACTA, Kurt describes the organization as a collaborative space for treasury professionals. They aim to provide networking and learning opportunities through various events and conferences.
ACTA works on collaborative networking, where members help each other by sharing knowledge, experiences, and opportunities. Kurt shares his experiences, highlighting the value of networking and sharing insights with others, ultimately benefiting the treasury community.
He advises professionals to approach networking to help others rather than gain something for themselves. He believes that helping others naturally stores up ‘credits’ which can be cashed in when needed.
In summary, the treasury landscape in Australia is quite diverse, with an active and collaborative professional network fostered by organizations like ACTA. The tight labour market for treasury professionals and a lack of opportunities for younger professionals must be addressed. Despite this, the treasury profession remains popular due to its rewarding nature and the country’s robust financial market.
How does the ACTA facilitate professional development, and what are its global expansion plans?
Kurt Smith, representing the Australian Corporate Treasury Association (ACTA), shares insights on two main aspects: their professional development initiatives and their global collaboration plans.
The Role of ACTA in Professional Development
ACTA organizes events that have an educational component. Even social gatherings, like their quarterly networking drinks, begin with an informative talk. The speakers might be from the treasury field or even outside of it. The goal here is to expose attendees to fresh perspectives and ideas they might not usually consider.
But it’s not just about exposing attendees to new ideas. ACTA is all about helping its members grow professionally. One of their recent projects has been the introduction of a Certificate in Corporate Treasury. This has been in their pipeline for a while, and it’s designed especially for less experienced treasury professionals. The goal? Attract university students and other finance professionals interested in transitioning into the treasury field.
More importantly, ACTA aims to raise the overall quality of potential treasury employees. Their goal is to reach a point where employers prefer to hire individuals who are certified treasury professionals and members of the association.
The certification isn’t just about academic knowledge, though. ACTA wants to provide practical, real-world examples to build on most treasury professionals’ academic base. So, they’ve incorporated plenty of case studies and videos featuring actual treasurers tackling real-world problems.
ACTA’s Global Expansion Plans
ACTA has started reaching out globally, forming relationships with other treasury associations. They’re just beginning this journey and want others to know they’re open to collaboration. They have valued long term connections such as INFINZ in New Zealand, and developing connections with TreasuryXL in the Netherlands, and TMI in the UK, amongst others. They even had a Board member attend an ACT event in Scotland!
ACTA is using platforms like podcasts and webinars to reach broader audiences. Kurt is open to hearing from anyone interested in forming a relationship with ACTA.
How Can Treasurers Use AI to Become More Strategic and Add More Value?
Hussam asks Kurt Smith about the role of Artificial Intelligence (AI) in transforming the role of corporate treasury functions. The main question revolves around how treasurers can leverage AI to become more strategic and less of a support function.
AI in Treasury Functions
Hussam introduces the idea of a treasurer becoming more strategic and less of a supporting function. The idea is that treasurers can add more value to their companies if they start seeing themselves as strategic business partners rather than just support teams. In this digital age where technology, especially AI, is advancing rapidly, Hussam is curious to know how treasurers can use AI to become more strategic.
Kurt Smith gives his perspective on this, highlighting that although he is not a technical expert in AI, he sees the potential in how technology, including AI, can improve treasury functions. As he sees it, technology can help reduce the time spent on tasks that don’t add much value but consume a lot of time, often referred to as high-volume, low-value tasks. By relieving Treasurers of this burden, they can focus instead on more strategic, high-value activities.
To illustrate this, Kurt shares a real-life example where he used digital technology to solve a business problem. He was given an underperforming insurance business to manage, with many complaints and claims backlogs. Using digital technology, Kurt triaged claims digitally, automating the low-value, high-volume tasks, which enabled the team to focus on the bigger ticket issues. This resulted in improved service and profitability for the business.
Transitioning from a Support Function to a Business Partner
The conversation also touches upon how treasurers can transition from being seen as a support function to becoming true business partners. Kurt agrees that this transition is key for the success of any company because the company’s strategy needs funding, which falls under the purview of the treasury, but the way capital is sourced, structured and allocated is determined only after obtaining a deep understanding of the business, its operating model, and commercial opportunities and threats.
He closes the conversation by emphasizing the rewarding nature of treasury work and how important it is for treasury professionals to recognize the influence and trust they hold in their companies.
Conclusion
In this evolving business landscape, the role of corporate treasury professionals has never been more critical. As we’ve explored in this article, treasurers play a vital role in managing finances and shaping strategic business decisions. They are the architects of financial strategies that support and drive growth, and their input can offer fresh perspectives on risk management, funding options, and investment opportunities.
As we delve into transitioning from an operational support function to a centre of strategic value-add, it’s clear that this shift requires both a change in mindset and practical tools. In this context, digital technology, particularly Artificial Intelligence, can play an instrumental role. By automating high-volume, low-value tasks, AI can free up treasurers’ time, allowing them to focus more on strategic, high-value tasks.
Real-life examples, like the one Kurt Smith shared, demonstrate this shift’s significant impact. By leveraging technology, treasury professionals can create efficiencies, improve services, and even transform an underperforming business into a profitable one.
Furthermore, treasurers have a unique opportunity to influence their companies’ futures. Their strategic input and funding acumen can make or break corporate strategies, underscoring the importance of role of corporate treasurer in the company.
Networking, too, is an essential part of a treasury professional’s journey. Associations like ACTA (the Australian Corporate Treasury Association) offer a platform for sharing experiences, learning from peers, and connecting with experts in the field.
In closing, treasury professionals have an exciting journey ahead. Embracing technology, viewing themselves as strategic partners, and leveraging networking opportunities can help them add more value to their companies and professional growth. As technology advances, the strategic importance and influence of treasury professionals are likely to grow, further enhancing the role of corporate treasury in shaping the future of their companies.
