Treasury Management
Unit 1: Introduction. 1.1 Objectives of treasury management. ? Availability and development in right quantity. ? Availability and development in right time. ? Profiting from availability and development. 1.2 Role and responsibilities of treasury manager. 1.3 Role of information technology in treasury management.
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: Unit 1 Introduction:
Introduction:
Treasury management (or treasury operations) is the science of managing treasury operations of a firm. Treasury in its literal sense refers to treasure or valuables of the government. The valuables are nothing but the coins and the currency which are medium of financial transactions in the country. In the earlier days when the level of operations was comparatively smaller, there used to be a centralized treasury into which the revenue receipts of the government were credited and form which the payments of the government were withdrawn. In a federal set-up, both the central govt. and the state govts. Had their treasuries for managing the inflows and outflows of the government finances. As the size and spread of government revenues grew, it became difficult to manage the flows of cash into centralized treasury. The function of collecting revenues on behalf of the government was gradually shifted to state bank of India and other nationalized banks. These banks also started making payments on behalf of state governments through cash counters and through bank accounts of various government departments. Simultaneously with the increase in size of government revenues, the corporate sector in India also grew
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manifold in operations. There were companies with multi-locational set-up involving receipt and disbursement of cash and cash equivalents at more than one place. In all such companies, the functions of treasury management developed analogous to the transfer of government treasury functions to banks. Along with this growth evolved the concept of profitable treasury management. Hitherto, the treasury management as practiced by the government was a passive concept. The over-riding motive was to provide a platform for transactions and little effort was made to evaluate the cost and expenses associated with managing large amount of currency, cheques and other liquid instruments. Similarly, the opportunity available for making profits from holding large liquid funds was not recognized. But with the arrival of corporate treasuries , the functions of treasury management was established as a profitable venture. Today when we speak of treasury management, we refer to all activities involving the management of revenues, inflows and outflows of government, banks and corporate etc. It is a general concept applicable to overflow fund management. Government as the sovereign power is the fountainhead of all treasury operations. It creates money by printing currency and minting coins. This money flows into various channels which take money to various users of currency and coinage as a medium of exchange. Thus at the macro level, the treasury operations revolve around Reserve Bank of India.RBI as a bankers to the govt. creates the banks and in this role, it controls the credit creation of banks. At the micro level the concept of treasury and its management is mirrored in small corporate units which manage the flows in a daily basis. As we move from macro level to micro level, the nomenclature of treasury management becomes diffused. The terms treasury management and fund management are used almost synonymously. Conceptually, the latter is a general term, applicable to the business sector, while treasury management refers to the management of cash, currency and credit of sovereign power of
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the country. The term currency here includes both national currency and the foreign currencies dealt with by the government. Historically, the treasury of a sovereign includes gold, silver and other precious metals which were used as a medium of exchange. As a ruler, the sovereign exercised unchallenged rights over all the precious metals extracted from the earth. The booties earned from wars, foreign exploits and domestic plundering kept on adding to the treasure chest of sovereign. These metals were circulated in the form of coins which became a medium of all commercial transactions in due course, replacing the earlier system of barter. The practice continued till the nineteenth century when paper currency began to be issued. Reserve Bank of India manages the macro treasury management of the country. This is done through ? ? ? issue of currency notes Distribution of small coins, one, two and five rupee coins and rupee notes on behalf of the government Maintenance of currency chests.
The currency is issued by the Reserve Bank of India in terms of Indian Currency Act whereas the small coins and rupee cons are issued the provisions of Indian Coinage Act. The provision of adequate supply of currency and coins is responsibility of the government which was at first discharged by providing currency chests at braches of Issue Department of RBI and at branches of imperial Bank of India (which later became state bank of India). SBI carried out the business of Government treasury and maintained the currency chests at all district headquarters. Later on all the nationalized banks were also entrusted with the task of maintenance of currency chests.
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The basic objective of keeping the currency chests at various places in India is to facilitate quick disbursement of currency and coins to far flung places and also to facilitate remittance to banks this way, the banks can remit surplus cash to the currency chests located in their region and avoid transportation of cash over long distances. Also, the banks can draw from the currency chests during time of need. Currency chests are the agents of the Reserve Bank of India for keeping custody of currency and coins. Any deposit of currency and coins into these chests implies that the money circulation has been curtailed to that extent. Similarly, any disbursal from these chests would expand their supply. Thus expansion and contraction of currency takes place in continual basis due to operation of the currency chests. Government as sovereign power has control on cash and currency circulated in the country. The issue of currency and coins is based on the treasured of the government in the form of gold and silver stocks which are supposed to back such issue. More recently, government securities and their promissory notes became the basis of such issue. In fact, the coins of gold and silver were the first replaced by the paper currency on the one hand and coins of base metals like copper, nickel, bronze, zinc etc, on the other. To supplement the available currency and to facilitate trade and business, credit instruments came into vogue in the form of promissory notes to pay at future date by thee trade and industry. Thus on the one hand, the government promissory notes became the basis for coins and currency rather than precious metals like gold and silver and on the other hand, the promissory notes of trade and industry became the source of credit instruments. These credit instruments particularly the safest among them such as government securities, in fact became the medium of parking of liquid funds over a period of time. Thus apart from handling cash and currency and banks funds, the liquid investment in government securities and mutual funds became another function of treasury management.
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Treasury function is a part of total managerial functions. Managerial function set-up can be classified into three broad units, viz. production function, marketing function and finance function. Production function pertains to the building up of capacities and generation of output. Marketing function is concerned with the marketing of the output through establishment of the sales and marketing network. In the finance function, the manager is concerned with financing of inputs and outputs and management of funds during the entire production cycle. Availability of cash, currency and credit by the government, business and foreign sectors is a must for macro operations of the economy. In broader terms, all financial resources including forex are to be made available to the micro-economic units, i. e. the companies. Similarly, the operations at the national level involve return flow of funds, repayment of loans, taxes, fees, etc. to the government, business and foreign sector. The finance function comes into play when the company is incorporated with capital restructuring; efforts are made for arriving at least cost combinations of capital for financing of a project and forecasting for working capital. In this function; one has to coordinate with the production and operations manager, sales or marketing manager and they together constitute the marketing team. Apart from arranging the requisite funds for commencing an activity, the finance function is also concerned with managing the dayto-day finances of the company. Whereas arranging project funds and working capital finance is a one-time assignment, management of funds on daily basis is a much more astute activity requiring forecasting skills and prioritization ability of a higher order. The inflows and outflows of funds, their coordination and synchronization and making arrangements for meeting any gap between them is only one end of the spectrum of finance function. The other end of the spectrum is the management of the surpluses and maximization of returns from short term fund. These two ends of the spectrum from the core of activities of finance function. But the handling of each of the activities requires further specialization. Arranging of long-term funds is the domain of the proper finance
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function but the management of funds required in and arising from day-to-day activities of the firm is the domain of the treasury function. These two have to be viewed together and analyzed for overall assessment of financial efficiency. So a finance manager need not have a treasury function or a treasury manager need not to be bothered with long term arrangement of funds. The finance manager can be termed as an arranger of funds whereas the treasury manager can be viewed as a manager of funds. Treasury management has both macro and micro aspects. At macro level, the inflows and outflows of cash, credit and other financial instruments are the functions of the government and the business sectors. These inflows are arranged by them as borrowing from the public. In these sectors, the ratio of savings to investments is less than one, i.e. the savings are inadequate to fund the investments. Hence the need for borrowing. They accordingly issue securities or promissory notes which are part of financial system. These borrowings for financial needs are met by surplus savings and funds of household and the foreign sector, where the ratio of savings to investments is positive. The micro units utilize these inflows and build up their capacities for production of output. This leads to establishment of a production system which logically leads us to the natural consequence, i.e. the establishment of distribution and consumption systems. Once the production, distribution and consumption systems are in place at micro level, the generation of surpluses at the units begins. These surpluses are channeled back into macro system as outflows from micro system. The inflows are the taxes paid to the government and repayment of loans made to the banks and financial institution. These inflows into the macro level have to be managed by the treasury managers at the macro level. While arranging funds for the micro units, the finance manager aims at optimizing the value of his assets or wealth and minimizing the burden of his liabilities. He may seek to maximize his operational profits and seek to maximize the wealth of stakeholders of the micro unit. The basic objectives are economy, efficiency and productivity of assets. These objectives cannot be achieved at the one end of the finance spectrum unless the
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management of funds at the other end of the spectrum unless the management of funds at the other end of the spectrum, i.e. the treasury segment is equally triggered by the dictums of economy, efficiency and productivity
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1.1 Objectives of Treasury Management
OBJECTIVES OF TREASURY MANAGEMENT:
Availability in right quantity.
Profiting from availability and development. Objectives
Development in right quantity.
Developement in right time.
Availabilty in right time.
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Availability in right quantity
The finance manager arranges funds for the unit. It is the duty of the treasury manager to ensure that after the funds have been arranged, these should be available in required quantity. The term quantity refers to the amount of funds required for day to day functioning of the unit. This quantity is available to the firm either as external loans or as internal generation. The loans quantity is arranged in the form of working capital finance. Working capital finance can be available as finance against any of the current assets, viz. inventory or receivables. In order to ensure that the working capital finance is available in adequate quantity, the treasury manager has to maintain the desired level of security of current assets against which the finance has been provided by the lenders. Maintenance of the security is not a direct function of the treasury manager because the security partly becomes available from the functioning of the production department and partly from the marketing department. The production department is responsible for manufacturing the products and keeping track of raw material, work in process and finished goods .These items from the inventory against which the working capital facility is provided. Similarly the marketing department is responsible for selling the goods and generating account receivables. Working capital finance is also provided by the banks against account receivables. Thus we can say that for maintenance of adequate security, the treasury manager has to coordinate with the production and marketing departments. The consequences of adequate security not being available in quantity can be far reaching. Let us assume that a firm has a credit facility of Rs.200 lacs provided by the banks against the security of inventory. It is a condition of the sanction of a loan that a margin of 25% shall be maintained by the firm against the security at all the times. It means that the firm can avail a credit facility of Rs.200 lacs only if it has a security of around Rs. 275 lacs. The security value is indicated by means of the inventory statement or the list of debtors depending upon whether the finance has been obtained against stocks or against
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book debts. This statement is provided to the banks on monthly basis usually. In case the statement is not given, the bank determines availability of credit on the basis of previous month’s statement. Thus if the statement of inventory and book debts is not provided to the bank well in time in case the value of security is higher than the previous period, then the firm stands to lose out on the availability of the differential amount of credit which it otherwise would have obtained. From the above illustration we can well imagine the importance of availability of adequate funds for day-to-day functioning of a firm. This function is one of the objectives of treasury management. Alongside, the treasury manager has also to ensure that the funds are just adequate for the requirement, the excess of requirement; the excess portion imposes an opportunity cost over the system, i.e. the cost represented by the earnings which these funds would have obtained instead of being left idle. Again, the adequacy of funds has to be determined carefully. For this purpose, the cash flows for the relevant period have to be accurately charted out. Cash flows are the actual cash flows in this case and not the projected cash flows. Between the projected cash flows and the actual cash flows, there can be a lag in terms of less ascertained, as regards outflows adequacy. Further, while actual inflows should be ascertained, as regards outflows a margin of contingency should be maintained to take care of the uncertainties. Cash is understood here to include both cash and bank balances plus portion of highly liquid securities that can be converted into cash within a stipulated time period.
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Development in right quantity
Just as procurement of funds in right quantity is important for treasury manager, equally important is to ensure that the right quantity of funds is deployment. By deployment of funds, we mean earmarking of funds for various expense heads parking of short-term funds and investing surplus funds The expense heads can be capital expenditure and revenue expenditure. Capital expenditure involves allocation of funds for acquisition of fixed assets. Such expenditure is not a routine occurrence. The amount involved per transactions in capital expenditure is large and such expenditure is usually known well in advance. Revenue expenditure on the other hand is routine expenditure for purchase of raw materials and making payments for utilities, wages and other miscellaneous items. The number of transactions for revenue expenditure is large and the amount involved per transactions is smaller as compared to the capital expenditure. Some items of revenue expenditure are in the form of cash payment but the capital expenditure is mainly through bank account. For deploying the right amount of funds, the treasury manager has to keep track of all receipts of funds. Simultaneously, the time table of deployment of funds is to be drawn up. In this time table, the payees are prioritized according to the urgency of their payments. There are certain expenses like important raw material payments utility payments etc. which have to be accorded top priority over others. Other payments like payments to capital goods suppliers and financiers have to also to be arranged in the right quantity. Apart from these payments, some extra funds have to be kept available for meeting contingencies. Te sun of all these deployments makes the right quantum of funds to be deployed. Co-ordination with the purchase department is required for raw material purchases. For fixed assets acquisition and loan repayments, coordination with the finance manager is needed. Liaison with administrative and HRD staff is required for deploying funds for utility and wages payments. Without this type of tie-up, right
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quantity of funds cannot be deployed. If the deployment is not in right quantity, the result can either be under deployment in case all the requirements of deployment of funds have been met and procurement of funds has been done in right quantity, there is a possibility that some amount of funds would remain in surplus with treasury department. This surplus would be in excess of the contingency requirements and as such can be deployed further on short term or long term basis depending upon the quantum of fund. If the quantum of surplus is large enough, some amount from this can be earmarked for long term deployment in investments etc. otherwise the entire surplus can be parked in short term securities. Short-term liquid securities are the Government securities and the schemes of mutual funds. Funds from these investments can be withdrawn at short notice period of 2-3 days as such these are skin to cash holding or bank balance holding.
Availability in right time
The requisite funds for day-to-day working of the firm should be available in time in addition to being available in quantity. By the term “availability in time” we mean that the funds should be available at the right moment, just in time so to say. The right time is the reasonable time taken to procure the funds. Procurement of funds is done by the firm in a number of ways and this activity is akin to the cash inflows. Cash inflows take place on account of (1) capital receipts like proceeds of loans or sale of assets (2) revenue receipts like sale proceeds of finished goods. Capital receipts are not a daily occurrence for the firm and their realization can be anticipated well in advance. The revenue receipts can flow in at a more random pace but with some amount of rigorous cash flow planning; even the trend of revenue inflows can be well anticipated. Once the cash flow planning, even the trend of revenue account has been planned, the priority of treasury manager remains to ensure that the schedule of conversion of realization into funds takes place as planned. Realization of capital receipts is more related to the domain of finance manager
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whereas realization of revenue proceeds falls within the domain of the marketing staff. The treasury manager has thus to coordinate the matter with both finance manager and the marketing manager in order to ensure that the realizations and receipts are converted into funds. Timely availability of funds smoothens the operations of the firm and brings about certainty to the quantum of inflows that would be available at a particular point in timely is a relative matter dependent upon the situation of each case again the inflows have to be actual inflows at the determined time and not projected or anticipated flows. This is because the element of uncertainty has to be accorded due to consideration. In case of a firm having a large number of transactions, timely availability of funds is extremely important because the execution of many transactions would be dependent upon funds position. This is relevant also for transactions involving foreign exchange. For the purpose of treasury operations, we consider foreign currencies at par with the domestic currency. It is assumed that the regulatory mechanism for holding foreign currency and domestic currency is the same and there is no constraint on holding or converting currencies. For foreign exchange transactions, funds have to be made available for meeting many critical situations. The treasury manager ensures that all the receipts of funds are credited to the account of the firm well in time. Another way of ensuring timely availability of funds is to park short-time surplus funds in liquid securities which can be sold conveniently and quickly to realize cash. In this way, availability can be ensured without straining other resources.
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Development at right time
A logical corollary of sourcing funds at the right time is that the funds should be deployed at the right time. The description of the right time is a relative term and what amount of time is appropriate varies from firm to firm. The span of time varies from a week to a month in case of purchase of fixed assets. However, in working capital deployment, the range of time allowed may be quite narrow- say 2-3 days only. The treasury manager has to honour the outstanding commitments on working capital account within this short span of time. Payment for wages and utilities etc. has to be made in time to avoid any defaults. Similarly, payment to trade creditors, domestic and overseas, has to made within a stipulated short period of time for avoiding interested payments etc. with the advancement in accounting systems aided by technological progress, it is now possible to send global remittances within no time. Funds can be procured more quickly than in the past, spanning the spatial barriers. The compulsion for online deployment is all the more pressing currently. The treasury manager seeks to priorities the deployments according to the ease of payment within the time horizon selected for planning deployment. Online payment of funds is ensured through offsite debits from a centralized pool banking account. Where such payments are possible, bank drafts or pay orders are purchased to ensure timely payment to pressing creditors. Timely disbursement ensures that the funds are not left idle for the shortest span of time. In case the sourcing and deployment of funds is well organized, surplus of funds shall soon start emerging which can be deployed in short term liquid investments. However, if the inflow and outflow of funds is not evenly matched in the time dimension, bottlenecks and mismatch of funds are sure to emerge. Apart from causing administration problems and rationing of fund, such a situation also leads to increase in cost of funds. Thus the treasury manager seeks to avoid such situations. Timely deployment of funds is
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a well planned activity requiring intra-organization co-ordination and liaison with banks and financial institutions apart from forex dealers.
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Profiting from availability and deployment
One of the prime objectives of a treasury manager is to ensure timely procurement of right amount of funds and timely deployment of right amount of funds. This objective results in administrative smoothening and paves way for easier achievement of performance targets of the firm. Modern day treasury manager has another objective, which is to profit from such sourcing and deployment. Profit from this function is derived as under. Sourcing of funds at right time and in right quantity is a result of realization of debtors and financing of borrowings. Realization of debtors in time has a direct impact upon profitability of the firm through decrease in cost of holding debtors. Financing of borrowings is a capital structure decision but the actual availment of these borrowings is
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the domain of the treasury manager, adequate and timely utilization of the borrowed funds results in the avoidance of strain on other sources of funds. Once the funds have been sourced in correct measure, the deployment adds further to the profitability of the firm it has been done in tandem with the pace of sourcing. Correct deployment ensures that there is no unnecessary accumulation of funds in the firm at any point in time. Needs of every department are met as per schedule. This action results in avoidance off special and extraordinary costs, interests and the like. With costs being in control, surplus funds emerge from the systems which are deployed profitably either as long term investments or as short-term parking tools. Both ways, the net result for the firm is an addition to profits.
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1.2 Role and responsibilities of treasury manager:
The overall financial starts with capital structuring, scouting for the least cost combination of internal and external capital of finance of the project and forecasting the sources and uses of funds. In this function, one has to coordinate with production and
marketing functions and all others that constitute the management team. The inflows and the outflows and their coordination and synchronization and meeting any gaps are the functions of the finance manager. The treasury manager has a large role of coordinating the apparently routine, yet significant activities are apparently routine because a sense of repetition is involved in these activities. Nevertheless, the activities are significant because smooth functioning of these activities pave the way for eventual solvency and profitability of the firm. The role and responsibilities of the treasury manager may be described as follows:
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Role of treasury manager:
A treasury manager has a significant part to play in the overall functioning of the firm. At any point of time he is engaged in a number of roles played. While the production manager or the marketing manager may be involved in the limited roles pertaining to their own fields, the roles of treasury manager intermingle with and overlap the other role sets. In any business entity which is engaged in marketing, a treasury manger could be performing a variety of roles. The expected roles to be carried out by him would be slightly less in number in case the firm is engaged in service activity but that does not deride the importance of treasury manager for a service organization. The treasury manager has the following roles:
a. Originating role:
The treasury manager inducts and originates system of accounting for the firms. Routine accounting of the firm is then carried out along these established systems. These established systems are the pivot around which the functioning of the unit revolves. For operations of these systems, the treasury manager complies exhaustive operations manual for the guidance of the user. It is expected that all the users shall comply with all important disclosure requirements for endorsing the integrity and validity of the systems.
b. Supportive roles:
The second role expected from the treasury manager is a supportive role. In this, the treasury manager supports the activities of the other departments like manufacturing, marketing and HRD. The support is evidenced through a meaningful and constructive coordination with the other departments. While doing this, the treasury manger is acting as extended arm of the financial manager in the annual budget. It is the duty of treasury manager to ensure that each department is able to spend the earmarked amount subject to completion of disclosure and documentation formalities.
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c. Leadership roles:
The treasury manager also has a leadership role to play. This role comes into play during times of exigency. An exigency could occur during time of systems breakdown. During such periods the treasury manager has to make alternative arrangements for transaction processing. While doing this, he has to act like a leader and carry the team along with him. Another example of exigency could be the situation when the firm is face to face with a sudden and unexpected liquidity crunch. During such an eventuality, the treasury manager has to use his ingenuity and leadership skills for tiding over the crunch. These skills could take the shape of postponing and privatizing payment and expediting recoveries.
d. Watchdog roles:
The treasury department is the eyes and ears of the management. Every financial transaction passes through its accounting system. As the processor of all the financial transactions, he keeps the watch on suspected bungling and frauds in the firm. He sets the examples for other departments of the firm by adhering the sound accounting practice and transparent dealings.
e. Learning role:
The accounting practices all over the world are in the state of constant flux due to evolution of new accounting concepts and technological changes. The treasury manager accepts these changes with an open mind and adopts the changes best suited to the organization. Simultaneously, he educates the other departments of firm also about the changes.
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f. Informative roles:
The treasury manger is the source of information for the top management regarding performance of the firm vis-à-vis the budgets. For conveying this information, he develops a management information system suited for the organization. This system provides concise and timely information on all the relevant parameters which enables the top management to take decisions.
Apart from the above roles, the treasury manger has the under mentioned responsibilities which he is expected to shoulder along with his roles:
1. Compliances with statutory guidelines:
While establishing operational system for the firm, the treasury manager has a duty to ensure that the system complies with the statutory and regulatory guidelines. Particularly, he has to take care of the provision regarding taxation and other government dues. He must ensure that the system should be simple and not cumbersome. The system should be transparent and it should protect the integrity of the transaction. Moreover, it should be impersonal and capable of being operated on the basis of reestablished guidelines. It should be flexible also to incorporate and subsequent changes in accounting and taxation norms.
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2. Equal treatment to all departments:
While playing the supporting role, the treasury manager has the responsibility of professionalism and impartiality. In accepting the demand of the expenditure from various departments, the treasury manager has to ensure that role is carried without any undue favour or bias. He has to keep the interest of the organization in mind and not to promote inter organization conflicts. The support that he provides must be detached and objective.
3. Ability to network:
While playing the leadership role in case of system breakdown or during period of cash crunch, the treasury manger should be able to exhibit traits of public relationships and networking. A crisis situation requires level of headedness and ability to think straight. What is also requires, is the ability to provide comforts to all users of the system. This can be done by exercising PR skills of high order. Apart from this, the treasury manager should have networking ability of outsourcing some of the accounting work to outside agencies during the period of interruption.
4. Integrity and impartial dealings:
Since the treasury manager is the watch dog of the management regarding the honest and straight dealings, he has to be impartial in his dealings. He must highlight the true states of affairs of the finance to the management. In case of any inadvertent shortcoming on the part of his department, the same should be admitted and the whole matter should be looked at in an impartial manner.
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5. Willingness to learn and to teach:
The treasury manger is required to keep him of all the development in the field. He should be able to pick out the latest developments that are likely to help his organization. He must accept ideas in an open minded state rather than treating new ideas as a threat of his fiefdom. Simultaneously he should be willing to teach and inculcate the latest development among his colleagues.
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1.3 Role of information technology in treasury management:
With the ever increasing to the pace of change to regulation, compliance and technology in the financial sector, treasury has increasingly become a strategic business partner across all areas of the business, adding value to the operating divisions of the company: for example, working with the sales department to establish good financial contracts terms so that any trade discount offered and the payment method agreed are beneficial to the business. The major role the information technology is playing in effective treasury management is as follows:
1. Automate repetitive tasks:
Technology today is being leveraged to automate repetitive tasks such as data gathering, accounting, ban polling, portfolio tracking and reporting. By automating this process, the delays and the possibilities of human error may be minimized. Automation also facilitates information sharing across departments, offices, and geographies and provides an accurate audit trial. Further more, auto mating these processes enables to focus on this value added tasks, critical to providing effective decision support to management team.
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2. Implement internal controls:
To ensure compliance with rule and regulations, sound and effective internal controls must be implemented. Thus focus should not only on system-related controls, but also on the clear cut segregation of duties. In treasury workstation, sophisticated rules must be implemented to ensure policy compliance. The solution that has obtained an internal audit and other compliance activities must be implemented.]
3. Time saver and fraud & error detection methodology:
This best practice is the great time saver, especially when it’s time to close the books. On the first day of the accounting c lose, there is a need to balance that day’s transaction is the previous day’s book data. Through the treasury management system, all repetitive transactions are automatically tagged with the correct instructions. Most companies using the treasury management system gets 90-95% of their transactions automatically tagged accurately without any manual interventions.
4. Forecast cash flows:
Effective forecasting helps managed financial risk by enabling to predict as cash short fall or liquidity crisis, taking into account interest rate changes and foreign exchange fluctuations. Forecasting also helps to enhance financial returns, enabling to make more effective decisions regarding investment and borrowing needs. Finally, forecasting helps maintain financial control by identifying unexpected occurrence for further reviews and actions.
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5. Communicate with operating units:
Operating units must be involved while building your forecast to ensure incorporation of all the necessary and up to date information. The past may not be indicative of the present so it’s important to have the latest and updated information. There must be benchmarking resulted at the operating unit level, and the cash forecasting result must be published. It’s important to keep a two-way flow of information by providing feedbacks to the operating unit based on how the actual compare to the forecasts. The treasury forecast performance matters must be compared to the forecast generated by the other groups and/or divisions. Significant variance may be indicators that treasury is not yet aware of all the information that should be included in the forecast.
6. Choose a web-based treasury management system:
The full benefit of technology without unnecessary costs or delays may be achieved by selecting a web based treasury management system. Web based solutions significantly reduce implementation cost and time frames and enables to access the system from wherever at any time. Furthermore, any enhancement to the system are automatically developed to all users, thus eliminating the needs to spend internal recourses on hardware or software acquisition, testing or downloads. To ensure the security of your information, select a system with two factors authentication and encryption technology must be selected.
7. Rethink treasury process:
There should be reassession of the treasury workstation at transparent intervals to evaluate processes and identify how they can/should be revised to maximize efficiencies. While reevaluating treasury management system, the focus should not only be the data, but on experience and knowledge.
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8. Pay for performance:
To reinforce the importance of forecasting, portfolio management, cash consolidation, and other value added activities across treasury department, benchmark should be defined. The proper and effective use of information technology in treasury operation increases the efficiency and effectiveness of corporate officers across the treasury, investor relations, corporate fiancé and corporate communication function.
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Unit 2: Functions and scope of treasury management. Unit level. Domestic level. International level.
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Unit 2 Functions and scope of treasury management:
Government sector, business sector and the foreign sector are the major sectors of country’s economy. For macro operations of these sectors, there is requirement of cash,
currency and credit. In broader terms, all financial resources
including foreign exchange are to be made available to the industrial or business units. Similarly, at the macro level return flow of funds in the form of taxes and repayment of loans is needed. Such to and form movement of funds is part of the financial functioning. Any business enterprise requires finance to start business operations. The first requirement is in the form of capital for setting up of the project. Project finance needs long term funds. These funds can be obtained from equity and debt both. Equity and internal accruals are considered the owners contribution whereas debt is treated as the outsider’s stake in the project. Once the company starts operations of production and manufacture, it needs working capital funds also. These funds are required to meet the payments for required to meet the payments for raw material and other inputs, spares, utilities etc. The quantum of funds needed for working capital depends upon nature of the company’s business and nature of its products or services.
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The function of treasury management is concerned with both macro and micro facets of the economy. At the macro level, the pumping in and out of cash, credit and other financial instruments are the functions of the government and business sectors, which borrow from the public. These two sectors spend more than their means and have to borrow in order to finance their ever-growing operations. They accordingly issue securities in the form of equity or debt instruments. The latter are securities including promissory notes and treasury bills which are redeemable after a stipulated time period. Such borrowings for financing the needs of the government and the business sector are met by surplus funds and savings of the household sector and the external sector. These two sectors have surplus of incomes over expenditure. Te micro units utilize these surpluses and build up their capacities for production of output and this leads to the productive system and distribution and consumption systems. No company can operate in a vacuum. Its assets are both financial and human. As such, there are both quantifiable and non-quantifiable factors involved in financial performance, forecasting and achievement of targets. The company’s treasury manager is the pivot around which day to day operations of the company revolve. His operations and performance have an impact on the company itself and the financial system and the economy in the broad sense. An analysis of the sources of funds of business units reveals that broadly there are three categories of resources – internal accruals of the unit, external sources from the capital and the money market and the external sources. The same analysis holds good at the sectoral and the national level. In fact, the emergence of the international financial markets can be traced to this sectoral inter-dependence, including the foreign sector and intra-national dependence. Basically, as no country is selfsufficient, international economic and economic relations emerge. In a similar fashion, it would be appropriate to set out the pattern of use of funds of any company into various sectors of the economy, including the foreign sector. Dispensation of funds for current or capital expenditures in domestic and international markets can be
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separately set out. Such an analysis is particularly more relevant to multinational corporations and braches or subsidiaries of foreign companies in whose case foreign markets and foreign sources of supply play an important part. The head office or holding company may spend apart of its funds in investment in the host country; make inward remittances for working capital or investment purposes and outward remittances for royalty and dividend payments or technical fees. International financial markets emerged out of the need to facilitate operations of nations arising out of commercial and financial transactions with the rest of the world. This emergence can be attributed logically to the inter-relations of the economic unit with the corporate sector and the latter with the sectors of the economy, including the foreign sector. It would b apt to set out here the inter-relations between micro level operations of a treasury manager with the macro level working of the corporate sector and foreign sector. A treasury manager with the micro unit in the financial sector. The environment he faces is competition from other similar units in the corporate sector. Besides this, the corporate sector, in turn, is inter-linked with all other sectors of the economy. The treasury manager is thus faced with a total environment of the economy which includes foreign sector and it is thus necessary for him to be familiar with the international financial system, as much as to the domestic financial system. Scope of treasury management can be broadly classified at the following levels as under:
? ? ?
unit level domestic level international level
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2.1 Unit level
At the unit level, the treasury manager’s activities encompass all other management functions. The performance of the production, marketing and HRD functions is dependent upon the performance of the treasury department. The lubricant for day-today functioning of a unit is money or funds and these funds are arranged by the treasury manager. The treasury is involved in all the budgeting activities of the unit, whether these are financial budget, costing budget, the marketing budget or the HRD budget. The feedback available from interactions with the various departments of the company is utilized by the treasury department to fine tune the overall performance targets of the company within the constraints of availability of currency, cash and cash equivalents. Treasury manager also monitors the cash flows of the unit on a conditional basis. It is ensured by him that adequate funds are made available for day-to-day working of the
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unit. In case there is genuine shortfall in cash flows, the outflows are made in an order of priority with the more urgent payments being made first. The treasury manager has two duties of taking decisions both in the areas of cash inflows and outflows. He has to integrate the treasury function with the production and marketing functions. The scope of the treasury management function at the unit level can be better described in the following routine duties of the treasury manager. 1. Keeping a track, on monthly, fortnightly or weekly basis, of all cash inflows and outflows and their variance with budget projections. 2. Maintaining a record of all receivables and payables, credit instruments, credit sales, deposits, loans and advances etc. 3. Study regularly the quantity and quality of current assets and liabilities and position of current liquidity. 4. Assess from time to time the long-term and short-term solvency of the company and its overall solvency position. 5. Keep liaison with stock exchanges, where the shares of the company are listed for a study of the share price movements. 6. Keep liaison with banks and financial institutions for ant change in borrowing limits or to inform them of any imminent changes in company’s financial position or policies. Payments of interest and installment of principal are to be arranged at the right times. 7. Keep liaison with Registrar of Companies and government departments concerned with the investment and financing decisions for any information regarding policy changes.
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8. Keep abreast with all legal and procedural requirements for raising funds and investment decisions. 9. Keep the top management or the board informed of any likely changes in the financial position of the company due to internal factors.
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2.2 Domestic level
At the domestic or national level, the scope of treasury management function is to channelize the savings of the community into profitable investment avenues. This job is performed by the commercial banks.
Treasury management is a crucial activity in banks and financial institutions as they deal with the funds, borrowing and lending and investments. By nature of their activity, they earn their profits through operations in money or near money claims. They borrow from the public in the form of deposits which along with other borrowings constitute their liabilities. Their assets are mostly of short form of loans, advances and investments. As their liabilities are mostly of short and medium term nature, funds management becomes critical for ensuring a proper matching of assets and liabilities according to the maturity of each and their costing. Commercial banks being the creators of credit have an additional responsibility of maintaining their image of creditworthiness, safety and integrity. Commercial banks are also required to observe capital adequacy norms and powers for non performing assets on a strict basis. Thus there are limits to which the banks can expand there credit portfolio. Banks are also enjoyed by regulations to maintain cash reserve ratio (CRR) of a minimum of 3% and statutory liquidity ratio (SLR) of 25% of their net demand and time liabilities. While the CRR is required to be maintained with RBI in the form of cash balance, the SLR is to be maintained in the form of investment in central and state government securities it has been observed that during the time of slacks credit demand, banks invest in government securities in a higher extent than a statutory requirement of
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25%of net DTL. This activity is more pronounced when the interest rates are falling because the yields in such a securities falls in such a period, driving up their prices. Banks, who does their treasury management astutely, stands to gain tremendous during such periods. The gilt edged market has two forms- primary and secondary. The primary market is a wholesale market where RBI is the underwriter and allots the securities to the applicants on behalf of the government. On the same basis, the RBI sells the repos (or repurchase agreements) of the government securities to the institutions, banks, etc. to meet the demands. The interest rates are decided by the discounts quoted to the securities to the banks, FIs, PF trust, etc. RBI as the underwriter of government securities makes up for any shortfall in subscription for them. But in the case of state government securities, it only agrees for subscription.
The main features of primary market are listed below:
? ? ? ? ? ? New borrowings to be made on behalf of government are decided by RBI and terms such as tenor and coupon rates are announced. The RBI acts as underwriter and contributes to the loan unsubscribed by the public. Work of the RBI is shared with the class of primary dealers. The timing and conditions, and the amount involved are discussed by RBI with the banks and FIs and sometimes prior commitments are enlisted. The floatation of bond is effected throughout the year depending on the conditions of market and the requirements of the government. The timing and quantum is also adjusted having regards to overall liquidity in the market. The subscription to the loan can be in cash as also in the form of rolling over of existing securities which have fallen due for repayment.
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In the secondary market, which is a retail market, trading is over the counter. Main operation in the secondary market is the Discount and Finance House of India (DFHI), banks, FIs, PFs etc. This market is an over the counter (OTC) market where trading is done through phones, fax etc. The concept of yield is important for understanding of government securities market. Yield as we know, it is a rate of return on an investment. In case of lending made by the banks, they stipulate the rate of interest per annum which becomes the benchmark of their returns. The actual yield may vary from the benchmark depending upon whether the periodicity of interest is monthly, quarterly or half yearly basis. In case of government securities, however the yields are determined on the basis of the price at which the security is auctioned in the primary market or the price determined in the secondary market through sale and purchase.
Nominal yield:
Coupon rate is the rate of interest payable per annum per rs. 100/- or the face value. If the purchase price is different from the face value than the return is equal to (coupon rate/purchase price)*100. This return is called the nominal yield.
Real yield:
Nominal yield are deflated by the index of inflation rate, such as WPI one CPI will give real yield, which reflects the true purchasing power of the return on these securities.
Net yield:
Nominal yield adjusted for the tax rate or payment of relevant taxes at which deduction of tax at source takes place are called the net yield.
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Current yield:
Coupon rate is the rate at which the bond carries interest. This is the nominal yield payable on the face value of the bond regularly and remains unaltered, say, for example 7.75% loan 2005. Current yield is equal to (coupon rate * face value)/cost or market price.
Redemption yield or yield to maturity:
This takes into account the price paid for the bond, length of time to maturity and the coupon rate of the bond. This is the yield which the holder gets per annum if he holds it until maturity and is the same as current yield if the bond is purchased at par. Resumption yield is equal to current yield +/- average annual capital gain or loss (for the bonds purchased in discount or premium as the case may be). RBI is responsible for public debt management of the government. It does this by underwriting and subscription to new issues not subscribed by public, by the use of open market operation (OMO) as a technique of sale or purchase of government. CRR as the method of controlling the liquidity and the internet rate structure and by the use of SLR and CRR as the method of controlling the liquidity of banking system and their contribution to government debt
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2.3 International level.
Functions of treasury management at international level:
At the international level the functions of treasury management is concerned with the management of funds in the foreign
currencies. Foreign exchange as a subject refers to the means and methods by which the rights to income and wealth in one currency are converted into similar fights in terms of another countries currency. Such exchanges may be in the form of one currency to another or on the conversion of credit instruments denominated in different currencies such as cheques, drafts, telegraphic transfers, bills of exchange, trade bills or promissory notes. Exchange is done through dealers in foreign exchange regulated by the central bank of the country. Banks are usually a dealer apart from other specialized agencies. One of the important components of the international financial system is the foreign exchange market. The various trade and commercial transaction between countries results in receipts and payment between them. These transactions are carried out t between the currencies of the concerned countries- any one of them or mutually agreed common currency. Either way transaction involves the conversion of currency to the other. The foreign exchange market facilitates such operations. The demand for goods and services from one country to another is the basis for demand for currencies in the market. Thus
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basically, demand for and supply of the foreign currencies arises from exporter and importers or the public having some transactions with foreign currencies. Companies having an import or export components in their business profile have to frequently deal in the forex operations. Forex operations in the country being supervised by the central bank, reference to the central bank in one form or the other is necessary use foreign exchange. If the country on the whole is a net exporter of goods and services. It would have surplus of foreign exchange, if on the other hand, it is a net importer then it would have the shortage of foreign exchange. The extent of regulation of the foreign market depends on the availability of foreign exchange in a country. If the forex is scares, then holding and using it would be subject to a lot of regulatory control. It also matters whether international trade forms a significant percentage of the GDP of a nation. If it is so, then the awareness about the forex regulation would be much more wide spread as compared to the situation where the foreign trade forms a significant portion of GDP. Presently, however, with increasing globalization, forex dealing has become a normal part of treasury operations. Every foreign exchange transaction involves a two way conversion- a purchase and sale. Conversion of domestic currency into foreign currency involves purchase of the later and sale of the former and vice versa. These transactions are routed through the banks. The takes the shape of either outright release of foreign currency for meeting the travel and related requirements or payment to outside parties in the denominated currency via the medium of correspondent banks. For effecting payment, following instruments are generally used:
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Telegraphic transfers (TT)
A TT is a transfer of money by telegram or cable or telex or fax from one center to another in a foreign currency. It is a method used by banks with their own codes and correspondent relations with banks and abroad for transmission of funds. As there is no loss if interest or capital risk in this mode, it enjoys the best rate for the value of receipts.
Mail transfers (MT)
It is an order to pay cash to a third party sent by a bank to its correspondent or branch abroad. It is issued in duplicate, one to the party buying it and the other to the correspondent bank. The amount is paid by the correspondent bank to the third party mentioned therein in the transferee country by its own cheque or by the by crediting in the party’s account. As the payment is made after the mail advice is received at the other end, which will take few days, the rate charged to the purchaser is cheaper to the extent of the interest gain to the seller bank.
Drafts and cheques:
Draft is a pay order issued by the banks on its own branch or correspondent bank abroad. It is payable on the sight but there is always a time lapse in the transit to in post between the payment by the purchaser of the drafts to his banks and the receipt of the money by the seller in the foreign center. As in the case of MT, there is risk of loss of draft in transit or delay in release of payment to the beneficiary and loss of interest in the intervening period.
Bills of exchange:
It is an unconditional order in writing addressed by one person to another, requiring the person to whom the order is addressed, to pay certain sum on demand or within a specified time period. If it is payable on demand, it is called a sight bill. If it is payable
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after a gap of some time, it is called a usance bill. Such bills can be banker’s bill or trader’s bill. Banker’s bill are drawn on banks abroad while trade bills are made between individual parties
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Unit 3: Treasury management vis-à-vis financial management. 3.1 3.2 3.3 model. 3.4 3.5 Organization models: dimensions. Tools of treasury management.
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Relationship between financial and Difference between financial and treasury Treasury organization: picking the right
treasury management. management.
Treasury Management
Unit 3 Treasury management vis-à-vis financial management. 3.1 Relationship between financial and treasury management
Finance function is a key element in the corporate activity. Its main objective is to keep a firm in a good financial health. To secure financial health, the finance manager has to perform the following functions: ? ? Investment functions and decisions Financing function and decisions
Investment functions estate to the efficient use of funds in alternate activities. The aim is to allocate funds to each activity so as to obtain optimal returns from such allocation. The short term and long term investment strategy has to be planned in line with the objective of maximization of wealth of shareholders. The utilization of funds as and when they accrue should take care of two prime considerations. The first consideration id that there should not be any idle funds and second consideration is that there should be no threat of liquidity crisis. Idle funds have there own cost and it results in lowering of there
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profitability. Extreme tightness of funds, on the other hand, raises the specter of default and loss of commercial reputation. So a delicate balance between these two conflicting objectives has to be maintained by the finance manager. It is in this context that the functions of finance become critical to the survival and growth of a firm. The financing function refers to the securing of the right resources of the funds at an appropriate cost and at the right times. Here the decision is to be taken about the least cost combination of funds for capital requirements and for working capital needs whether owner’s equity should be used for financing or should the firm resort to external financing? If the owner’s equity is to be arranged. What returns are to be assured? If borrowing has to be done, then what rate of interest is to be paid? In line with the twin objective of investment and financing, the finance manager has to take responsibility for all decisions pertaining to these areas. In the finance functions, a macro view of the requirements and uses of funds is to be taken. The finance manager has to arrange the funds within the approved capital structure of the firm. The funds may be debt or equity. Once the funds have been arranged it is left tot the treasury functions to utilize these funds according to the approved parameters. Finance management is also concerned with the overall solvency and profitability of the firm. By overall solvency we mean that the funds should be able at all times to meet its liabilities. The liabilities can be short term or long term. The long term liabilities pertain to payment of long term borrowings. Internal liabilities like payments to shareholders are matter of consideration once external solvency has been attained by the firm. Profitability means that the firm may at times face strain upon their profitability due to macro-economic or internal causes. But the firm should be in a position to earn reasonable return on its investments on capital employed. Capital operation of the firm means that both the owned funds and borrowed funds generate adequate surpluses for the firm. This can be ensured by investing the funds in such projects which provides optimal returns. The treasury function is concerned with management of funds at the micro level. It means that once the funds
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have been arranged and investments identified, handlings of the funds generated from the activities of the firm should be monitored with a view to carry out the operations smoothly. Since funds or cash in the lubricant of all business activity, availability of funds on day to day basis is to be ensured by the treasury manager. The role of treasury management is to manage funds in an efficient manager, so that the operations in the area of finance are facilitated in relation to the business profile of the firm. The treasury function is thus supplemental and complimented to the finance function. As supplemental functions, it reinforces the activities of the finance function by taking care of the finer points while the latter delineates the board contours. As a complimentary function, the treasury manger takes care even those areas which the finance function does not touch. Looked at marketing functions than the finance function. This is because the treasury department of a firm is involved in more frequent interaction with other departments. For the purpose of performing this role, the treasury manager operates in various financial markets including the inter corporate market, money market, g-sec market, forex market etc
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3.2 Difference between financial and treasury management.
Following differences can be observed between financial management and treasury management:
1. Control aspects:
The objective of financial management is to establish, coordinate and
administer as an integral part of the management, an adequate plan for control of operations, such a plan provide for capital investment
programs, profit budgets, sales forecasts, expenses budgets and cost standards. The objective of treasury management is to execute the plan of finance function. Execution of the plan takes care of the issue arising in routine operations of the firm which have a bearing upon the funds position. Thus the finance function of a firm would fix the limit for investment in short term instruments for a firm for example. It is the treasury function that would decide which particular instruments are to be invested in within the overall limit having regard to safety, liquidity and profitability. Again the finance function would arrange the borrowed funds for the firm but the treasury function would take care of day to day monitoring of the funds.
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2. Reporting aspects:
Financial management is concerned with the preparation of overall financial reports of the firm such as profit and loss account and the balance sheet. It also takes care of the taxation aspects and external audit. Based upon the performance of the firm, budget for the ensuring years are fixed. The reports are submitted to the top management of the firm. Treasury management is concerned with monitoring the income and expenses budget on the periodic basis vis-à-vis the budgets are fixed department/segment wise so as to dovetail with the overall corporate budgets. Variance from the budgets is analyzed by the treasury department on the continual basis for taking corrective measures. The corrective measures that can be taken are pointing out of the discrepancies to departmental heads and refuse payments that are not according to approved procedures and guidelines. The treasury department is also involved in the internal audit of the firm.
3. Strategic aspects:
The financial functions is involved in formulating overall financial strategy firm. The top management chooses the line of activity for the firm. The finance function firms up the investment and financing plans fir the activity. The strategic choices before the financial manager are the options for the investments and financing. While making the financial manager is taking a long term view of the states of affairs. It is just possible that the business of a firm may not be profitable in the initial years but it does not mean that the choice regarding investing has been strategically incorrect. In fact, there are many mega projects where the gestation period is even up to seven years. But given the correctness of the original assumptions, performance of the finance function would be measured by the number of years that gets reduced in breaking even. Strategy for treasury managements more short term in nature. The treasury manager has to decide about the tolls of accounting and development of systems for generation of
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controlling reports. The maintenance of proper system of accounting is one of the objectives of the treasury management. Another strategic objective for treasury management would be maintained of short term liquidity. This is done through regulation of payments and speedy realization of receivables.
4. Nature of assets:
The finance manager is concerned with creation of fixed assets for the firm. Fixed assets are those assets which yield benefit to the firm over a longer period of time. It can be said that the time span of a project coincides with the span of the fixed assets. In case the fixed assets have depreciated physically by significant measures, then a decision has to be taken for up gradation and replacement of the assets. The treasury manager is concerned with the net current assets of the firm. Net current assets are the difference between the current assets and current liabilities of the firm, both normally realizable within a period of one year. Current assets always are more than the current liabilities for ensuring liquidity of the firm. Current assets are the inventory, receivables and cash balances. Current liabilities are the trade creditors, statutory payables and loan repayable within one year. To ensure a healthy level of net current assets, the treasury manager is to ensure that the quality of the assets does not deteriorate. As regards investments, the finance manger is concerned with long term and strategic investments. These investments could be funded from borrowed funds or from internal accruals. The investments are expected to be held over a longer period of time as such day to day monitoring of the investments is not required. The treasury manager is concerned with short term investments. The tenor and quality of these investments has to be constantly monitored by the treasury manager for ensuring safety and profitability.
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3.3 Treasury organization: picking the right model.
Organizations have extended debates on the kinds of treasury they should have. The common themes include services that the treasury should offer the right size or structure and the right spread of management control. There are many dimensions to the structure of the treasury organization. Two key dimensions- range of services and extent of centralization of management control – define resultant organization models. The relationship between organization models and factors that influence decisions on the right models. The relationship between organization models and factors that influence decisions on the right model to adopt. There are various definitions of the word treasury. In its strictness sense, it refers to one function: asset liability management, especially when used in the context of banks. In a wider sense, treasury includes a whole range of activities encompassing various markets. A few significant activities are: Asset liability management: ? ? ? Maturity mismatch Interest rate type mismatch; Currency mismatch
Sales and trading: ? ? ? Currency, interest rate and credit products; Money market and long tenor instruments; and Derivative products
Risk management: ? ? Back office processing, settlement, and accounting; and Customer and regulatory reporting.
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3.4 Organization models: dimensions.
Any organization can exercise its choice on the scope of the treasury functions it undertakes. In doing this, it may be governed by a variety of considerations: ? It may choose to handle only those needs driven by utilitarian motives such as liquidity support or on the other hand, it may consider treasury as a “core” organizational process and hence handle the full range of services. ? It may choose to outsource portion of activities required or it may choose to foster these capabilities in house. Independently, an organization can also decide on the extent of centralization of the treasury management: ? ? It may be efficient to centralize back office processing, while the front office may need to be decentralized to aid speedy local decision making. It may be important to have a common risk management strategy, while execution may be decentralized. A study of common practices relating to the two key influencers – the range of activities supported and the degree of centralization or decentralization – at the treasury organizations globally suggests four models.
Full service global
Full service refers to the treasury that undertakes most, if not all, of the activities of the treasury management. Global treasury refers to one that either operated as the only treasury for all market across the globe, or ultimately combines all regional or local treasuries (that may exist due to legal or regulatory reasons) into a central treasury for pooling risk, for policies or strategies, for both these. In this sense, management of the
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treasury function in this model is very much centralized. Although this model readily lends itself to global organizations, it could also be used by local business that need to access global markets.
Full service local:
In this model, each treasury is a self contained local unit dictated purely by the needs of the local business. Thus, the treasury management functions are, by and large, decentralized. While this sort of treasury is usually the norm for a business with a local or regional spread. It may be adopted for global organization that operates as a collection of highly independent business units. Again, the range of services offered is full gamut, as described in the full service global model above.
Limited service global:
This model is different from the full services global model in that the range of services offered is limited. This could largely be due to the fact that certain activities are kept outside the purview of treasury and are handled directly by business units because the scale of these activities is not large enough to warrant the attention of the central treasury activities, with the exposure being managed directly by the concerned export or import or not managed at all. For those activities that are included in the treasury in such a model, pooling is a central level.
Limited service local:
This model is akin to having virtually little or no treasury activities, beyond local cash and liquidity management. These are very small decentralized treasuries where the concerned managers may also have other responsibilities in the finance department.
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3.5 Tools of treasury management.
Tools of treasury management:
Treasury manager is required to work in the fast changing and competitive environment. For carrying out his activities, he has to resort to certain tools and techniques. Most of the tools are originated from the finance
department and as such cannot be considered to be an exclusive prerogative of the treasury department. Yes it is the treasury manager who uses these tools most extensively. The tools are being described below:
1. Analytic and planning tools:
In the treasury functions, planning and budgeting are essential to achieve target and to keep effective control on costs. Analysis of data and information is necessary for planning and budgeting. Performance budgeting is referred to as setting of physical targets for each line of activity. The financial outlay or expenditure needed for each is earmarked to choose the least cost mode of activity. To achieve the targets. Productivity and efficiency improves by decentralization of responsibility and that is achieved by performance budgeting. Where each department or section is made a profit centre and is accountable for its targets, financial involvement and its profits in financial terms, relative to the targets in physical terms.
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This type of planning involving performance budgeting is best suited for service industry say a financial services company or bank where every department can function in a decentralized manner and achieve the targets.
2. Zero based budgeting:
Another tool of analysis and performance is zero based budgeting wherein each manager establishes objectives for his functions and gains agreement on them with top management. Then alternative ways for achieving these objectives are defined and the most partial way for achieving the target is selected. This objective for each incremental level of activity, costs and benefits are assessed. The alternative with the least cost is then selected.
3. Financial statement analysis:
Financial analysis of the company is necessary to help the treasury manager to decide whether to invest in the company. Such analysis also helps the company in internal controls. The soundness and the intrinsic worth of the company are known only by such analysis. The market price of the share depends, among the other things on the sound fundamentals of the company, the financial and the operational efficiency and the profitability of that company. These factors can be known by the study of the financial statements of the company.
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Unit 4: Regulation and environment of treasury management. 4.1 4.2 4.3 4.4 Internal treasury control. Treasury control mechanism. Environment for treasury control. Supervision of treasury operations
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Unit 4 Regulation management. 4.1 Internal treasury control.
All the economic units have the goal of profit maximization or wealth maximization. This objective is achieved by shot term and long term planning of funds. These plans are incorporated in the budgets in the form of activities and corresponding targets are fixed accordingly. The next step in the process is the control function to see that the budget is being implemented as per plans. Control is thus part of planning and budgeting in an organization. Control is the process of monitoring to ensure that the activities are being carried out as per plans. It is also noticed whether there is any divergence from the plans, what are the reasons for divergence and what are the remedial actions can be suggested.
and
environment
of
treasury
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Internal treasury control is a process of self improvement. It is concerned with the flow of funds, cash and credit and all financial aspects of operations. Fro time to time and on regular basis, the internal treasury control is exercised on financial targets. The financial aspects of operation include procuring of inputs, paying creditors, making arrangements of finance against inventories and receivables. The gaps between inflows and outflows are met by planned resource to low cost mix of financing. The control aims at operational efficiency and removal of wastage and efficiencies and promoting of cost effectiveness in the firm. The control is exercised under phases of planning and budgeting. These phases include setting up of targets, laying down financial standards, evaluation of performance as per these norms and reporting in a standard format. The quarterly and annual budgets would set the targets for each department and financial standards are set out for each activity. Monthly budgets are evaluated by the performance sheets maintained daily and regular reports go to the financial controller. Reporting and evaluation go together and on the basis of information system built in the past, plans are prepared for the next period.
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4.2 Treasury control mechanism.
Treasury management relates to the most of the highly volatile instrument’s market dealing. The volumes of transactions involved in the dealings are usually heavy and risks in operations are also heavy. So any unorganisation operation will create heavy loss for the institution. Generally control system may be related to a. Internal control of different, dealing rooms, settlement office and control offices. b. Checking of unhealthy insider trading systems. c. Mutual and amicable solutions of different conflicts of interest in dealing operations.
Internal control system: It relates to forming policies to check leakage of profit to the institution. In treasury operation, the role of central office is vital. They should form suitable guidelines for the institutions in respect of various treasury dealing operations. There are advices dealing operations to diffract all treasury items in different classes according to risk involvement. As a treasury business is a risky business responsible positioned persons should be delegated powers to deal in treasury operations with imposition of different limits on their discretionary powers.
Some important areas should be taken:
i. ii. Fixation of rates on each treasury items Fixing limits on dealers to deal with different counter parties, with proper observation of confidentiality and adherence to best market practice.
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Treasury executive should be ensured that the transactions id carried in a correct manner by cross checking during each dealing day. For above facts the central offices should develop proper policies and guidelines for treasury operations and should advice the dealers to deal according to policies of the following:
i. ii.
Restriction on dealing in one’s own account. Timely advice to deal offices in respect of any adverse transactions received or excess reporting.
iii. iv. v.
Timely submission of returns to different statutory authorities. Review of securities and contingencies arrangement of different offices. Proper verification of compliance given by lower offices for irregularities.
Insider dealings:
Insiders are those who are in management including near and dear, and their dealings means taking advantages of published internal information of the corporate body. These may create price sensex situation. So these unadvantage dealings should properly efficient internal control system should be taken by the management to eliminate insider dealing by fixing penalties for insider dealers.
Treasury operations in banking:
All banks/financial institutions (core principals and brokers) should ensure that they should try to serve for giving best services in the market operations with code of conducts issued for time to time. Core principals should be conducted noninvestment business with private individuals should segregate them into retail or wholesale for smooth function of business within sound guidelines. It is essential that all staff should be familiar to code of
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conducts. In professional manner while entering into dealing transactions.
Banks/financial institution will be responsible for dealing actions of the staff members. It should be segregate work for the staff members such as no staff member should control the full operation. Banks/financial institution should identify any potential or actual conflicts of the interest that might arise while undertaking wholesale market transaction; and take measures either to eliminate these measures and to provide fair treatment to counter parties. Banks/financial institutions should know their counter parties and their credit worthiness before entering into contract. It is good practice for principals, subject to their own legal advice, to alert counter party to any legal or tax uncertainty which they know are relevant to be proposed relationships or their transactions. All relationships have their responsibilities to assessing the credit worthiness of their counter parties whether dealing directly or through broker/firms. Banks/financial institutions should take measure of risk control and to meet legal financial obligation for each contract to minimize the loss. It is better to prepare a dealing mandates for each transaction. The mandate will be helpful to clarify the extent of the relationship between core principals and their customers with responsibility. Banks/financial institutions should observe confidentiality. It is essential for the privation of the reputable and efficient market place for banks/financial institution. The transaction should not be dealt in non market rates. So this practice should be avoided. Adequate safeguards should be established to prevent abuse of information by staff members with respect to non public price sensitive information.
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4.3 Environment for treasury control.
Environment for treasury management:
Treasury management is carried out in the real corporate world and the corporate functioning is carried out in the overall corporate environment. Environment of treasury operation can broadly be classified as under:
a. Legal environment b. Regulatory environment c. Financial environment a. Legal environment:
By legal environment we refer to the legislation where govern corporate functioning. These legislations are the one pertaining the company law, taxation industrial regulation etc.
b. Regulatory environment:
The regulatory environment encompasses regulation regarding employment, wages, and laws, promotion of units and closure of units etc.
c. Financial environment:
The financial environment pertains to policies regarding monetary and fiscal control, financial supervision, exchange control etc
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4.4 Supervision of treasury operations.
The treasury operation department is responsible for treasury’s middle and back office functions, all systems services, and particularly cash management and banking relation services. Treasury operation’s cross-functional staffs provide pricing and valuation, performance measurement, transaction and securities processing and compliance support functions. The middle staff provides quantitative analytic support and operational risk reporting and coordinates treasury’s control risk assessment related to internal related to internal corporate governance and risk management functions. Treasury operations implement and manage information system in support of treasury’s asset management, funding, pension investment, and cash operations functions. The role of treasury manager is to manage mitigate and monitor financial risk arising due to difference in currency basis and timing of pledges from donors, disbursements and debt services. The risk management rules that are used include among the others currency swaps and currency forwards interest rate swaps and currency forwards rate agreements. Treasury management comes under master derivatives agreement and hedges risk positions using its counterparties in the market.
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Risk management generally incorporates:
? ? ? A prudent approach to balance sheet management, with the aim of mitigating and controlling financial risks; Suitable risk limits and policies and procedures formulated to ensures that the limits are not breached; and Appropriate systems, controls and reporting mechanism for measuring and monitoring residual risks. In this context, the role of treasury manager typically includes:
a. Policy analysis:
Develop the risk management framework, taking into account board’s risk preferences, balance sheet dynamics and market limitations, as well as credit, interest rate operational; and foreign currency risks, and the different instruments available for risk transfer.
b. Strategy design:
Advice on the optimal risk transfer through a broad based still risk to be hedged out and the instruments available, based on the modeling and evaluation of risk management options.
c. Structuring; negotiating and executing transactions:
The treasury manager is responsible to efficiently remove interest rate and foreign currency exposure based on board approved risk management strategy; typical decision making on the risk management strategies; tactical decision making on overall execution strategy and timing for transaction on the different currencies to accommodate to market and liquidity limitations; benchmark counterpart market quotes based on in-house models negotiate prices and ensures best execution.
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Present status of treasury management in India:
Treasury management is still in infancy in India. It is still considered as a sub function of the financial management. In most of the companies, it is the finance manager which is also taking care of treasury functions. Treasury operations are carried out professionally and systematically by some banks and financial institutions. The first stage of evolution in treasury management is the establishment of a treasury function. The second stage is running it as a profit center. In India, treasury operations at the micro level are expected to grow at a fast pace with increasing integration of the Indian economy with the world economy.
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Conclusion
Treasury management is the science of managing treasury operations of a firm. Treasury in its literal sense refers to treasure or the valuables of the government. ? Macro level: It is the inflows and outflows of cash, credit and other financial instruments are the functions of the government and the business sectors. These inflows are arranged by them as borrowing from public. In this sectors the ratio of savings to investment is less than one, i.e. the savings are inadequate to fund the investments ? Micro level: the finance manger aims at optimizing the value of his assets or wealth and minimizing the burden of his liabilities. He may seek to maximize his operational profits and seek to maximize the wealth of stakeholders of the micro level. ? The availability of funds in right quantity, Availability in right time, Deployment in right quantity, Deployment in right time and profiting from availability and deployment are the main objectives of the Treasury Management. ? ? At unit level, treasury manager’s activities encompass all other management functions. Treasury manager monitors the cash flows of the unit on a continual basis. It is ensured by him that adequate funds are made available for day to day working of the unit. In case there is genuine shortfall in cash flows, the outflows are made in an order of priority with the more urgent payments being m ? ? At domestic level or national level treasury management function is o channelizing the savings of the community into profitable investments avenues. At the international level, the function of treasury management is concerned with management of funds in the foreign currencies.
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? ? ? Analytic and planning tools, Zero based Budgeting and Financial Statement Analysis are the various Tools of treasury management. Internal treasury control is a process of self improvement which is concerned with all flows of funds, and credit and all financial aspects of operations. Environment for treasury management can be broadly classified as Legal environment, Regulatory environment and financial environment.
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doc_353084685.docx
Unit 1: Introduction. 1.1 Objectives of treasury management. ? Availability and development in right quantity. ? Availability and development in right time. ? Profiting from availability and development. 1.2 Role and responsibilities of treasury manager. 1.3 Role of information technology in treasury management.
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: Unit 1 Introduction:
Introduction:
Treasury management (or treasury operations) is the science of managing treasury operations of a firm. Treasury in its literal sense refers to treasure or valuables of the government. The valuables are nothing but the coins and the currency which are medium of financial transactions in the country. In the earlier days when the level of operations was comparatively smaller, there used to be a centralized treasury into which the revenue receipts of the government were credited and form which the payments of the government were withdrawn. In a federal set-up, both the central govt. and the state govts. Had their treasuries for managing the inflows and outflows of the government finances. As the size and spread of government revenues grew, it became difficult to manage the flows of cash into centralized treasury. The function of collecting revenues on behalf of the government was gradually shifted to state bank of India and other nationalized banks. These banks also started making payments on behalf of state governments through cash counters and through bank accounts of various government departments. Simultaneously with the increase in size of government revenues, the corporate sector in India also grew
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manifold in operations. There were companies with multi-locational set-up involving receipt and disbursement of cash and cash equivalents at more than one place. In all such companies, the functions of treasury management developed analogous to the transfer of government treasury functions to banks. Along with this growth evolved the concept of profitable treasury management. Hitherto, the treasury management as practiced by the government was a passive concept. The over-riding motive was to provide a platform for transactions and little effort was made to evaluate the cost and expenses associated with managing large amount of currency, cheques and other liquid instruments. Similarly, the opportunity available for making profits from holding large liquid funds was not recognized. But with the arrival of corporate treasuries , the functions of treasury management was established as a profitable venture. Today when we speak of treasury management, we refer to all activities involving the management of revenues, inflows and outflows of government, banks and corporate etc. It is a general concept applicable to overflow fund management. Government as the sovereign power is the fountainhead of all treasury operations. It creates money by printing currency and minting coins. This money flows into various channels which take money to various users of currency and coinage as a medium of exchange. Thus at the macro level, the treasury operations revolve around Reserve Bank of India.RBI as a bankers to the govt. creates the banks and in this role, it controls the credit creation of banks. At the micro level the concept of treasury and its management is mirrored in small corporate units which manage the flows in a daily basis. As we move from macro level to micro level, the nomenclature of treasury management becomes diffused. The terms treasury management and fund management are used almost synonymously. Conceptually, the latter is a general term, applicable to the business sector, while treasury management refers to the management of cash, currency and credit of sovereign power of
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the country. The term currency here includes both national currency and the foreign currencies dealt with by the government. Historically, the treasury of a sovereign includes gold, silver and other precious metals which were used as a medium of exchange. As a ruler, the sovereign exercised unchallenged rights over all the precious metals extracted from the earth. The booties earned from wars, foreign exploits and domestic plundering kept on adding to the treasure chest of sovereign. These metals were circulated in the form of coins which became a medium of all commercial transactions in due course, replacing the earlier system of barter. The practice continued till the nineteenth century when paper currency began to be issued. Reserve Bank of India manages the macro treasury management of the country. This is done through ? ? ? issue of currency notes Distribution of small coins, one, two and five rupee coins and rupee notes on behalf of the government Maintenance of currency chests.
The currency is issued by the Reserve Bank of India in terms of Indian Currency Act whereas the small coins and rupee cons are issued the provisions of Indian Coinage Act. The provision of adequate supply of currency and coins is responsibility of the government which was at first discharged by providing currency chests at braches of Issue Department of RBI and at branches of imperial Bank of India (which later became state bank of India). SBI carried out the business of Government treasury and maintained the currency chests at all district headquarters. Later on all the nationalized banks were also entrusted with the task of maintenance of currency chests.
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The basic objective of keeping the currency chests at various places in India is to facilitate quick disbursement of currency and coins to far flung places and also to facilitate remittance to banks this way, the banks can remit surplus cash to the currency chests located in their region and avoid transportation of cash over long distances. Also, the banks can draw from the currency chests during time of need. Currency chests are the agents of the Reserve Bank of India for keeping custody of currency and coins. Any deposit of currency and coins into these chests implies that the money circulation has been curtailed to that extent. Similarly, any disbursal from these chests would expand their supply. Thus expansion and contraction of currency takes place in continual basis due to operation of the currency chests. Government as sovereign power has control on cash and currency circulated in the country. The issue of currency and coins is based on the treasured of the government in the form of gold and silver stocks which are supposed to back such issue. More recently, government securities and their promissory notes became the basis of such issue. In fact, the coins of gold and silver were the first replaced by the paper currency on the one hand and coins of base metals like copper, nickel, bronze, zinc etc, on the other. To supplement the available currency and to facilitate trade and business, credit instruments came into vogue in the form of promissory notes to pay at future date by thee trade and industry. Thus on the one hand, the government promissory notes became the basis for coins and currency rather than precious metals like gold and silver and on the other hand, the promissory notes of trade and industry became the source of credit instruments. These credit instruments particularly the safest among them such as government securities, in fact became the medium of parking of liquid funds over a period of time. Thus apart from handling cash and currency and banks funds, the liquid investment in government securities and mutual funds became another function of treasury management.
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Treasury function is a part of total managerial functions. Managerial function set-up can be classified into three broad units, viz. production function, marketing function and finance function. Production function pertains to the building up of capacities and generation of output. Marketing function is concerned with the marketing of the output through establishment of the sales and marketing network. In the finance function, the manager is concerned with financing of inputs and outputs and management of funds during the entire production cycle. Availability of cash, currency and credit by the government, business and foreign sectors is a must for macro operations of the economy. In broader terms, all financial resources including forex are to be made available to the micro-economic units, i. e. the companies. Similarly, the operations at the national level involve return flow of funds, repayment of loans, taxes, fees, etc. to the government, business and foreign sector. The finance function comes into play when the company is incorporated with capital restructuring; efforts are made for arriving at least cost combinations of capital for financing of a project and forecasting for working capital. In this function; one has to coordinate with the production and operations manager, sales or marketing manager and they together constitute the marketing team. Apart from arranging the requisite funds for commencing an activity, the finance function is also concerned with managing the dayto-day finances of the company. Whereas arranging project funds and working capital finance is a one-time assignment, management of funds on daily basis is a much more astute activity requiring forecasting skills and prioritization ability of a higher order. The inflows and outflows of funds, their coordination and synchronization and making arrangements for meeting any gap between them is only one end of the spectrum of finance function. The other end of the spectrum is the management of the surpluses and maximization of returns from short term fund. These two ends of the spectrum from the core of activities of finance function. But the handling of each of the activities requires further specialization. Arranging of long-term funds is the domain of the proper finance
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function but the management of funds required in and arising from day-to-day activities of the firm is the domain of the treasury function. These two have to be viewed together and analyzed for overall assessment of financial efficiency. So a finance manager need not have a treasury function or a treasury manager need not to be bothered with long term arrangement of funds. The finance manager can be termed as an arranger of funds whereas the treasury manager can be viewed as a manager of funds. Treasury management has both macro and micro aspects. At macro level, the inflows and outflows of cash, credit and other financial instruments are the functions of the government and the business sectors. These inflows are arranged by them as borrowing from the public. In these sectors, the ratio of savings to investments is less than one, i.e. the savings are inadequate to fund the investments. Hence the need for borrowing. They accordingly issue securities or promissory notes which are part of financial system. These borrowings for financial needs are met by surplus savings and funds of household and the foreign sector, where the ratio of savings to investments is positive. The micro units utilize these inflows and build up their capacities for production of output. This leads to establishment of a production system which logically leads us to the natural consequence, i.e. the establishment of distribution and consumption systems. Once the production, distribution and consumption systems are in place at micro level, the generation of surpluses at the units begins. These surpluses are channeled back into macro system as outflows from micro system. The inflows are the taxes paid to the government and repayment of loans made to the banks and financial institution. These inflows into the macro level have to be managed by the treasury managers at the macro level. While arranging funds for the micro units, the finance manager aims at optimizing the value of his assets or wealth and minimizing the burden of his liabilities. He may seek to maximize his operational profits and seek to maximize the wealth of stakeholders of the micro unit. The basic objectives are economy, efficiency and productivity of assets. These objectives cannot be achieved at the one end of the finance spectrum unless the
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management of funds at the other end of the spectrum unless the management of funds at the other end of the spectrum, i.e. the treasury segment is equally triggered by the dictums of economy, efficiency and productivity
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1.1 Objectives of Treasury Management
OBJECTIVES OF TREASURY MANAGEMENT:
Availability in right quantity.
Profiting from availability and development. Objectives
Development in right quantity.
Developement in right time.
Availabilty in right time.
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Availability in right quantity
The finance manager arranges funds for the unit. It is the duty of the treasury manager to ensure that after the funds have been arranged, these should be available in required quantity. The term quantity refers to the amount of funds required for day to day functioning of the unit. This quantity is available to the firm either as external loans or as internal generation. The loans quantity is arranged in the form of working capital finance. Working capital finance can be available as finance against any of the current assets, viz. inventory or receivables. In order to ensure that the working capital finance is available in adequate quantity, the treasury manager has to maintain the desired level of security of current assets against which the finance has been provided by the lenders. Maintenance of the security is not a direct function of the treasury manager because the security partly becomes available from the functioning of the production department and partly from the marketing department. The production department is responsible for manufacturing the products and keeping track of raw material, work in process and finished goods .These items from the inventory against which the working capital facility is provided. Similarly the marketing department is responsible for selling the goods and generating account receivables. Working capital finance is also provided by the banks against account receivables. Thus we can say that for maintenance of adequate security, the treasury manager has to coordinate with the production and marketing departments. The consequences of adequate security not being available in quantity can be far reaching. Let us assume that a firm has a credit facility of Rs.200 lacs provided by the banks against the security of inventory. It is a condition of the sanction of a loan that a margin of 25% shall be maintained by the firm against the security at all the times. It means that the firm can avail a credit facility of Rs.200 lacs only if it has a security of around Rs. 275 lacs. The security value is indicated by means of the inventory statement or the list of debtors depending upon whether the finance has been obtained against stocks or against
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book debts. This statement is provided to the banks on monthly basis usually. In case the statement is not given, the bank determines availability of credit on the basis of previous month’s statement. Thus if the statement of inventory and book debts is not provided to the bank well in time in case the value of security is higher than the previous period, then the firm stands to lose out on the availability of the differential amount of credit which it otherwise would have obtained. From the above illustration we can well imagine the importance of availability of adequate funds for day-to-day functioning of a firm. This function is one of the objectives of treasury management. Alongside, the treasury manager has also to ensure that the funds are just adequate for the requirement, the excess of requirement; the excess portion imposes an opportunity cost over the system, i.e. the cost represented by the earnings which these funds would have obtained instead of being left idle. Again, the adequacy of funds has to be determined carefully. For this purpose, the cash flows for the relevant period have to be accurately charted out. Cash flows are the actual cash flows in this case and not the projected cash flows. Between the projected cash flows and the actual cash flows, there can be a lag in terms of less ascertained, as regards outflows adequacy. Further, while actual inflows should be ascertained, as regards outflows a margin of contingency should be maintained to take care of the uncertainties. Cash is understood here to include both cash and bank balances plus portion of highly liquid securities that can be converted into cash within a stipulated time period.
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Development in right quantity
Just as procurement of funds in right quantity is important for treasury manager, equally important is to ensure that the right quantity of funds is deployment. By deployment of funds, we mean earmarking of funds for various expense heads parking of short-term funds and investing surplus funds The expense heads can be capital expenditure and revenue expenditure. Capital expenditure involves allocation of funds for acquisition of fixed assets. Such expenditure is not a routine occurrence. The amount involved per transactions in capital expenditure is large and such expenditure is usually known well in advance. Revenue expenditure on the other hand is routine expenditure for purchase of raw materials and making payments for utilities, wages and other miscellaneous items. The number of transactions for revenue expenditure is large and the amount involved per transactions is smaller as compared to the capital expenditure. Some items of revenue expenditure are in the form of cash payment but the capital expenditure is mainly through bank account. For deploying the right amount of funds, the treasury manager has to keep track of all receipts of funds. Simultaneously, the time table of deployment of funds is to be drawn up. In this time table, the payees are prioritized according to the urgency of their payments. There are certain expenses like important raw material payments utility payments etc. which have to be accorded top priority over others. Other payments like payments to capital goods suppliers and financiers have to also to be arranged in the right quantity. Apart from these payments, some extra funds have to be kept available for meeting contingencies. Te sun of all these deployments makes the right quantum of funds to be deployed. Co-ordination with the purchase department is required for raw material purchases. For fixed assets acquisition and loan repayments, coordination with the finance manager is needed. Liaison with administrative and HRD staff is required for deploying funds for utility and wages payments. Without this type of tie-up, right
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quantity of funds cannot be deployed. If the deployment is not in right quantity, the result can either be under deployment in case all the requirements of deployment of funds have been met and procurement of funds has been done in right quantity, there is a possibility that some amount of funds would remain in surplus with treasury department. This surplus would be in excess of the contingency requirements and as such can be deployed further on short term or long term basis depending upon the quantum of fund. If the quantum of surplus is large enough, some amount from this can be earmarked for long term deployment in investments etc. otherwise the entire surplus can be parked in short term securities. Short-term liquid securities are the Government securities and the schemes of mutual funds. Funds from these investments can be withdrawn at short notice period of 2-3 days as such these are skin to cash holding or bank balance holding.
Availability in right time
The requisite funds for day-to-day working of the firm should be available in time in addition to being available in quantity. By the term “availability in time” we mean that the funds should be available at the right moment, just in time so to say. The right time is the reasonable time taken to procure the funds. Procurement of funds is done by the firm in a number of ways and this activity is akin to the cash inflows. Cash inflows take place on account of (1) capital receipts like proceeds of loans or sale of assets (2) revenue receipts like sale proceeds of finished goods. Capital receipts are not a daily occurrence for the firm and their realization can be anticipated well in advance. The revenue receipts can flow in at a more random pace but with some amount of rigorous cash flow planning; even the trend of revenue inflows can be well anticipated. Once the cash flow planning, even the trend of revenue account has been planned, the priority of treasury manager remains to ensure that the schedule of conversion of realization into funds takes place as planned. Realization of capital receipts is more related to the domain of finance manager
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whereas realization of revenue proceeds falls within the domain of the marketing staff. The treasury manager has thus to coordinate the matter with both finance manager and the marketing manager in order to ensure that the realizations and receipts are converted into funds. Timely availability of funds smoothens the operations of the firm and brings about certainty to the quantum of inflows that would be available at a particular point in timely is a relative matter dependent upon the situation of each case again the inflows have to be actual inflows at the determined time and not projected or anticipated flows. This is because the element of uncertainty has to be accorded due to consideration. In case of a firm having a large number of transactions, timely availability of funds is extremely important because the execution of many transactions would be dependent upon funds position. This is relevant also for transactions involving foreign exchange. For the purpose of treasury operations, we consider foreign currencies at par with the domestic currency. It is assumed that the regulatory mechanism for holding foreign currency and domestic currency is the same and there is no constraint on holding or converting currencies. For foreign exchange transactions, funds have to be made available for meeting many critical situations. The treasury manager ensures that all the receipts of funds are credited to the account of the firm well in time. Another way of ensuring timely availability of funds is to park short-time surplus funds in liquid securities which can be sold conveniently and quickly to realize cash. In this way, availability can be ensured without straining other resources.
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Development at right time
A logical corollary of sourcing funds at the right time is that the funds should be deployed at the right time. The description of the right time is a relative term and what amount of time is appropriate varies from firm to firm. The span of time varies from a week to a month in case of purchase of fixed assets. However, in working capital deployment, the range of time allowed may be quite narrow- say 2-3 days only. The treasury manager has to honour the outstanding commitments on working capital account within this short span of time. Payment for wages and utilities etc. has to be made in time to avoid any defaults. Similarly, payment to trade creditors, domestic and overseas, has to made within a stipulated short period of time for avoiding interested payments etc. with the advancement in accounting systems aided by technological progress, it is now possible to send global remittances within no time. Funds can be procured more quickly than in the past, spanning the spatial barriers. The compulsion for online deployment is all the more pressing currently. The treasury manager seeks to priorities the deployments according to the ease of payment within the time horizon selected for planning deployment. Online payment of funds is ensured through offsite debits from a centralized pool banking account. Where such payments are possible, bank drafts or pay orders are purchased to ensure timely payment to pressing creditors. Timely disbursement ensures that the funds are not left idle for the shortest span of time. In case the sourcing and deployment of funds is well organized, surplus of funds shall soon start emerging which can be deployed in short term liquid investments. However, if the inflow and outflow of funds is not evenly matched in the time dimension, bottlenecks and mismatch of funds are sure to emerge. Apart from causing administration problems and rationing of fund, such a situation also leads to increase in cost of funds. Thus the treasury manager seeks to avoid such situations. Timely deployment of funds is
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a well planned activity requiring intra-organization co-ordination and liaison with banks and financial institutions apart from forex dealers.
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Profiting from availability and deployment
One of the prime objectives of a treasury manager is to ensure timely procurement of right amount of funds and timely deployment of right amount of funds. This objective results in administrative smoothening and paves way for easier achievement of performance targets of the firm. Modern day treasury manager has another objective, which is to profit from such sourcing and deployment. Profit from this function is derived as under. Sourcing of funds at right time and in right quantity is a result of realization of debtors and financing of borrowings. Realization of debtors in time has a direct impact upon profitability of the firm through decrease in cost of holding debtors. Financing of borrowings is a capital structure decision but the actual availment of these borrowings is
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the domain of the treasury manager, adequate and timely utilization of the borrowed funds results in the avoidance of strain on other sources of funds. Once the funds have been sourced in correct measure, the deployment adds further to the profitability of the firm it has been done in tandem with the pace of sourcing. Correct deployment ensures that there is no unnecessary accumulation of funds in the firm at any point in time. Needs of every department are met as per schedule. This action results in avoidance off special and extraordinary costs, interests and the like. With costs being in control, surplus funds emerge from the systems which are deployed profitably either as long term investments or as short-term parking tools. Both ways, the net result for the firm is an addition to profits.
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1.2 Role and responsibilities of treasury manager:
The overall financial starts with capital structuring, scouting for the least cost combination of internal and external capital of finance of the project and forecasting the sources and uses of funds. In this function, one has to coordinate with production and
marketing functions and all others that constitute the management team. The inflows and the outflows and their coordination and synchronization and meeting any gaps are the functions of the finance manager. The treasury manager has a large role of coordinating the apparently routine, yet significant activities are apparently routine because a sense of repetition is involved in these activities. Nevertheless, the activities are significant because smooth functioning of these activities pave the way for eventual solvency and profitability of the firm. The role and responsibilities of the treasury manager may be described as follows:
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Role of treasury manager:
A treasury manager has a significant part to play in the overall functioning of the firm. At any point of time he is engaged in a number of roles played. While the production manager or the marketing manager may be involved in the limited roles pertaining to their own fields, the roles of treasury manager intermingle with and overlap the other role sets. In any business entity which is engaged in marketing, a treasury manger could be performing a variety of roles. The expected roles to be carried out by him would be slightly less in number in case the firm is engaged in service activity but that does not deride the importance of treasury manager for a service organization. The treasury manager has the following roles:
a. Originating role:
The treasury manager inducts and originates system of accounting for the firms. Routine accounting of the firm is then carried out along these established systems. These established systems are the pivot around which the functioning of the unit revolves. For operations of these systems, the treasury manager complies exhaustive operations manual for the guidance of the user. It is expected that all the users shall comply with all important disclosure requirements for endorsing the integrity and validity of the systems.
b. Supportive roles:
The second role expected from the treasury manager is a supportive role. In this, the treasury manager supports the activities of the other departments like manufacturing, marketing and HRD. The support is evidenced through a meaningful and constructive coordination with the other departments. While doing this, the treasury manger is acting as extended arm of the financial manager in the annual budget. It is the duty of treasury manager to ensure that each department is able to spend the earmarked amount subject to completion of disclosure and documentation formalities.
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c. Leadership roles:
The treasury manager also has a leadership role to play. This role comes into play during times of exigency. An exigency could occur during time of systems breakdown. During such periods the treasury manager has to make alternative arrangements for transaction processing. While doing this, he has to act like a leader and carry the team along with him. Another example of exigency could be the situation when the firm is face to face with a sudden and unexpected liquidity crunch. During such an eventuality, the treasury manager has to use his ingenuity and leadership skills for tiding over the crunch. These skills could take the shape of postponing and privatizing payment and expediting recoveries.
d. Watchdog roles:
The treasury department is the eyes and ears of the management. Every financial transaction passes through its accounting system. As the processor of all the financial transactions, he keeps the watch on suspected bungling and frauds in the firm. He sets the examples for other departments of the firm by adhering the sound accounting practice and transparent dealings.
e. Learning role:
The accounting practices all over the world are in the state of constant flux due to evolution of new accounting concepts and technological changes. The treasury manager accepts these changes with an open mind and adopts the changes best suited to the organization. Simultaneously, he educates the other departments of firm also about the changes.
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f. Informative roles:
The treasury manger is the source of information for the top management regarding performance of the firm vis-à-vis the budgets. For conveying this information, he develops a management information system suited for the organization. This system provides concise and timely information on all the relevant parameters which enables the top management to take decisions.
Apart from the above roles, the treasury manger has the under mentioned responsibilities which he is expected to shoulder along with his roles:
1. Compliances with statutory guidelines:
While establishing operational system for the firm, the treasury manager has a duty to ensure that the system complies with the statutory and regulatory guidelines. Particularly, he has to take care of the provision regarding taxation and other government dues. He must ensure that the system should be simple and not cumbersome. The system should be transparent and it should protect the integrity of the transaction. Moreover, it should be impersonal and capable of being operated on the basis of reestablished guidelines. It should be flexible also to incorporate and subsequent changes in accounting and taxation norms.
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2. Equal treatment to all departments:
While playing the supporting role, the treasury manager has the responsibility of professionalism and impartiality. In accepting the demand of the expenditure from various departments, the treasury manager has to ensure that role is carried without any undue favour or bias. He has to keep the interest of the organization in mind and not to promote inter organization conflicts. The support that he provides must be detached and objective.
3. Ability to network:
While playing the leadership role in case of system breakdown or during period of cash crunch, the treasury manger should be able to exhibit traits of public relationships and networking. A crisis situation requires level of headedness and ability to think straight. What is also requires, is the ability to provide comforts to all users of the system. This can be done by exercising PR skills of high order. Apart from this, the treasury manager should have networking ability of outsourcing some of the accounting work to outside agencies during the period of interruption.
4. Integrity and impartial dealings:
Since the treasury manager is the watch dog of the management regarding the honest and straight dealings, he has to be impartial in his dealings. He must highlight the true states of affairs of the finance to the management. In case of any inadvertent shortcoming on the part of his department, the same should be admitted and the whole matter should be looked at in an impartial manner.
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5. Willingness to learn and to teach:
The treasury manger is required to keep him of all the development in the field. He should be able to pick out the latest developments that are likely to help his organization. He must accept ideas in an open minded state rather than treating new ideas as a threat of his fiefdom. Simultaneously he should be willing to teach and inculcate the latest development among his colleagues.
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1.3 Role of information technology in treasury management:
With the ever increasing to the pace of change to regulation, compliance and technology in the financial sector, treasury has increasingly become a strategic business partner across all areas of the business, adding value to the operating divisions of the company: for example, working with the sales department to establish good financial contracts terms so that any trade discount offered and the payment method agreed are beneficial to the business. The major role the information technology is playing in effective treasury management is as follows:
1. Automate repetitive tasks:
Technology today is being leveraged to automate repetitive tasks such as data gathering, accounting, ban polling, portfolio tracking and reporting. By automating this process, the delays and the possibilities of human error may be minimized. Automation also facilitates information sharing across departments, offices, and geographies and provides an accurate audit trial. Further more, auto mating these processes enables to focus on this value added tasks, critical to providing effective decision support to management team.
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2. Implement internal controls:
To ensure compliance with rule and regulations, sound and effective internal controls must be implemented. Thus focus should not only on system-related controls, but also on the clear cut segregation of duties. In treasury workstation, sophisticated rules must be implemented to ensure policy compliance. The solution that has obtained an internal audit and other compliance activities must be implemented.]
3. Time saver and fraud & error detection methodology:
This best practice is the great time saver, especially when it’s time to close the books. On the first day of the accounting c lose, there is a need to balance that day’s transaction is the previous day’s book data. Through the treasury management system, all repetitive transactions are automatically tagged with the correct instructions. Most companies using the treasury management system gets 90-95% of their transactions automatically tagged accurately without any manual interventions.
4. Forecast cash flows:
Effective forecasting helps managed financial risk by enabling to predict as cash short fall or liquidity crisis, taking into account interest rate changes and foreign exchange fluctuations. Forecasting also helps to enhance financial returns, enabling to make more effective decisions regarding investment and borrowing needs. Finally, forecasting helps maintain financial control by identifying unexpected occurrence for further reviews and actions.
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5. Communicate with operating units:
Operating units must be involved while building your forecast to ensure incorporation of all the necessary and up to date information. The past may not be indicative of the present so it’s important to have the latest and updated information. There must be benchmarking resulted at the operating unit level, and the cash forecasting result must be published. It’s important to keep a two-way flow of information by providing feedbacks to the operating unit based on how the actual compare to the forecasts. The treasury forecast performance matters must be compared to the forecast generated by the other groups and/or divisions. Significant variance may be indicators that treasury is not yet aware of all the information that should be included in the forecast.
6. Choose a web-based treasury management system:
The full benefit of technology without unnecessary costs or delays may be achieved by selecting a web based treasury management system. Web based solutions significantly reduce implementation cost and time frames and enables to access the system from wherever at any time. Furthermore, any enhancement to the system are automatically developed to all users, thus eliminating the needs to spend internal recourses on hardware or software acquisition, testing or downloads. To ensure the security of your information, select a system with two factors authentication and encryption technology must be selected.
7. Rethink treasury process:
There should be reassession of the treasury workstation at transparent intervals to evaluate processes and identify how they can/should be revised to maximize efficiencies. While reevaluating treasury management system, the focus should not only be the data, but on experience and knowledge.
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8. Pay for performance:
To reinforce the importance of forecasting, portfolio management, cash consolidation, and other value added activities across treasury department, benchmark should be defined. The proper and effective use of information technology in treasury operation increases the efficiency and effectiveness of corporate officers across the treasury, investor relations, corporate fiancé and corporate communication function.
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Unit 2: Functions and scope of treasury management. Unit level. Domestic level. International level.
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Unit 2 Functions and scope of treasury management:
Government sector, business sector and the foreign sector are the major sectors of country’s economy. For macro operations of these sectors, there is requirement of cash,
currency and credit. In broader terms, all financial resources
including foreign exchange are to be made available to the industrial or business units. Similarly, at the macro level return flow of funds in the form of taxes and repayment of loans is needed. Such to and form movement of funds is part of the financial functioning. Any business enterprise requires finance to start business operations. The first requirement is in the form of capital for setting up of the project. Project finance needs long term funds. These funds can be obtained from equity and debt both. Equity and internal accruals are considered the owners contribution whereas debt is treated as the outsider’s stake in the project. Once the company starts operations of production and manufacture, it needs working capital funds also. These funds are required to meet the payments for required to meet the payments for raw material and other inputs, spares, utilities etc. The quantum of funds needed for working capital depends upon nature of the company’s business and nature of its products or services.
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The function of treasury management is concerned with both macro and micro facets of the economy. At the macro level, the pumping in and out of cash, credit and other financial instruments are the functions of the government and business sectors, which borrow from the public. These two sectors spend more than their means and have to borrow in order to finance their ever-growing operations. They accordingly issue securities in the form of equity or debt instruments. The latter are securities including promissory notes and treasury bills which are redeemable after a stipulated time period. Such borrowings for financing the needs of the government and the business sector are met by surplus funds and savings of the household sector and the external sector. These two sectors have surplus of incomes over expenditure. Te micro units utilize these surpluses and build up their capacities for production of output and this leads to the productive system and distribution and consumption systems. No company can operate in a vacuum. Its assets are both financial and human. As such, there are both quantifiable and non-quantifiable factors involved in financial performance, forecasting and achievement of targets. The company’s treasury manager is the pivot around which day to day operations of the company revolve. His operations and performance have an impact on the company itself and the financial system and the economy in the broad sense. An analysis of the sources of funds of business units reveals that broadly there are three categories of resources – internal accruals of the unit, external sources from the capital and the money market and the external sources. The same analysis holds good at the sectoral and the national level. In fact, the emergence of the international financial markets can be traced to this sectoral inter-dependence, including the foreign sector and intra-national dependence. Basically, as no country is selfsufficient, international economic and economic relations emerge. In a similar fashion, it would be appropriate to set out the pattern of use of funds of any company into various sectors of the economy, including the foreign sector. Dispensation of funds for current or capital expenditures in domestic and international markets can be
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separately set out. Such an analysis is particularly more relevant to multinational corporations and braches or subsidiaries of foreign companies in whose case foreign markets and foreign sources of supply play an important part. The head office or holding company may spend apart of its funds in investment in the host country; make inward remittances for working capital or investment purposes and outward remittances for royalty and dividend payments or technical fees. International financial markets emerged out of the need to facilitate operations of nations arising out of commercial and financial transactions with the rest of the world. This emergence can be attributed logically to the inter-relations of the economic unit with the corporate sector and the latter with the sectors of the economy, including the foreign sector. It would b apt to set out here the inter-relations between micro level operations of a treasury manager with the macro level working of the corporate sector and foreign sector. A treasury manager with the micro unit in the financial sector. The environment he faces is competition from other similar units in the corporate sector. Besides this, the corporate sector, in turn, is inter-linked with all other sectors of the economy. The treasury manager is thus faced with a total environment of the economy which includes foreign sector and it is thus necessary for him to be familiar with the international financial system, as much as to the domestic financial system. Scope of treasury management can be broadly classified at the following levels as under:
? ? ?
unit level domestic level international level
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2.1 Unit level
At the unit level, the treasury manager’s activities encompass all other management functions. The performance of the production, marketing and HRD functions is dependent upon the performance of the treasury department. The lubricant for day-today functioning of a unit is money or funds and these funds are arranged by the treasury manager. The treasury is involved in all the budgeting activities of the unit, whether these are financial budget, costing budget, the marketing budget or the HRD budget. The feedback available from interactions with the various departments of the company is utilized by the treasury department to fine tune the overall performance targets of the company within the constraints of availability of currency, cash and cash equivalents. Treasury manager also monitors the cash flows of the unit on a conditional basis. It is ensured by him that adequate funds are made available for day-to-day working of the
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unit. In case there is genuine shortfall in cash flows, the outflows are made in an order of priority with the more urgent payments being made first. The treasury manager has two duties of taking decisions both in the areas of cash inflows and outflows. He has to integrate the treasury function with the production and marketing functions. The scope of the treasury management function at the unit level can be better described in the following routine duties of the treasury manager. 1. Keeping a track, on monthly, fortnightly or weekly basis, of all cash inflows and outflows and their variance with budget projections. 2. Maintaining a record of all receivables and payables, credit instruments, credit sales, deposits, loans and advances etc. 3. Study regularly the quantity and quality of current assets and liabilities and position of current liquidity. 4. Assess from time to time the long-term and short-term solvency of the company and its overall solvency position. 5. Keep liaison with stock exchanges, where the shares of the company are listed for a study of the share price movements. 6. Keep liaison with banks and financial institutions for ant change in borrowing limits or to inform them of any imminent changes in company’s financial position or policies. Payments of interest and installment of principal are to be arranged at the right times. 7. Keep liaison with Registrar of Companies and government departments concerned with the investment and financing decisions for any information regarding policy changes.
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8. Keep abreast with all legal and procedural requirements for raising funds and investment decisions. 9. Keep the top management or the board informed of any likely changes in the financial position of the company due to internal factors.
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2.2 Domestic level
At the domestic or national level, the scope of treasury management function is to channelize the savings of the community into profitable investment avenues. This job is performed by the commercial banks.
Treasury management is a crucial activity in banks and financial institutions as they deal with the funds, borrowing and lending and investments. By nature of their activity, they earn their profits through operations in money or near money claims. They borrow from the public in the form of deposits which along with other borrowings constitute their liabilities. Their assets are mostly of short form of loans, advances and investments. As their liabilities are mostly of short and medium term nature, funds management becomes critical for ensuring a proper matching of assets and liabilities according to the maturity of each and their costing. Commercial banks being the creators of credit have an additional responsibility of maintaining their image of creditworthiness, safety and integrity. Commercial banks are also required to observe capital adequacy norms and powers for non performing assets on a strict basis. Thus there are limits to which the banks can expand there credit portfolio. Banks are also enjoyed by regulations to maintain cash reserve ratio (CRR) of a minimum of 3% and statutory liquidity ratio (SLR) of 25% of their net demand and time liabilities. While the CRR is required to be maintained with RBI in the form of cash balance, the SLR is to be maintained in the form of investment in central and state government securities it has been observed that during the time of slacks credit demand, banks invest in government securities in a higher extent than a statutory requirement of
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25%of net DTL. This activity is more pronounced when the interest rates are falling because the yields in such a securities falls in such a period, driving up their prices. Banks, who does their treasury management astutely, stands to gain tremendous during such periods. The gilt edged market has two forms- primary and secondary. The primary market is a wholesale market where RBI is the underwriter and allots the securities to the applicants on behalf of the government. On the same basis, the RBI sells the repos (or repurchase agreements) of the government securities to the institutions, banks, etc. to meet the demands. The interest rates are decided by the discounts quoted to the securities to the banks, FIs, PF trust, etc. RBI as the underwriter of government securities makes up for any shortfall in subscription for them. But in the case of state government securities, it only agrees for subscription.
The main features of primary market are listed below:
? ? ? ? ? ? New borrowings to be made on behalf of government are decided by RBI and terms such as tenor and coupon rates are announced. The RBI acts as underwriter and contributes to the loan unsubscribed by the public. Work of the RBI is shared with the class of primary dealers. The timing and conditions, and the amount involved are discussed by RBI with the banks and FIs and sometimes prior commitments are enlisted. The floatation of bond is effected throughout the year depending on the conditions of market and the requirements of the government. The timing and quantum is also adjusted having regards to overall liquidity in the market. The subscription to the loan can be in cash as also in the form of rolling over of existing securities which have fallen due for repayment.
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In the secondary market, which is a retail market, trading is over the counter. Main operation in the secondary market is the Discount and Finance House of India (DFHI), banks, FIs, PFs etc. This market is an over the counter (OTC) market where trading is done through phones, fax etc. The concept of yield is important for understanding of government securities market. Yield as we know, it is a rate of return on an investment. In case of lending made by the banks, they stipulate the rate of interest per annum which becomes the benchmark of their returns. The actual yield may vary from the benchmark depending upon whether the periodicity of interest is monthly, quarterly or half yearly basis. In case of government securities, however the yields are determined on the basis of the price at which the security is auctioned in the primary market or the price determined in the secondary market through sale and purchase.
Nominal yield:
Coupon rate is the rate of interest payable per annum per rs. 100/- or the face value. If the purchase price is different from the face value than the return is equal to (coupon rate/purchase price)*100. This return is called the nominal yield.
Real yield:
Nominal yield are deflated by the index of inflation rate, such as WPI one CPI will give real yield, which reflects the true purchasing power of the return on these securities.
Net yield:
Nominal yield adjusted for the tax rate or payment of relevant taxes at which deduction of tax at source takes place are called the net yield.
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Current yield:
Coupon rate is the rate at which the bond carries interest. This is the nominal yield payable on the face value of the bond regularly and remains unaltered, say, for example 7.75% loan 2005. Current yield is equal to (coupon rate * face value)/cost or market price.
Redemption yield or yield to maturity:
This takes into account the price paid for the bond, length of time to maturity and the coupon rate of the bond. This is the yield which the holder gets per annum if he holds it until maturity and is the same as current yield if the bond is purchased at par. Resumption yield is equal to current yield +/- average annual capital gain or loss (for the bonds purchased in discount or premium as the case may be). RBI is responsible for public debt management of the government. It does this by underwriting and subscription to new issues not subscribed by public, by the use of open market operation (OMO) as a technique of sale or purchase of government. CRR as the method of controlling the liquidity and the internet rate structure and by the use of SLR and CRR as the method of controlling the liquidity of banking system and their contribution to government debt
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2.3 International level.
Functions of treasury management at international level:
At the international level the functions of treasury management is concerned with the management of funds in the foreign
currencies. Foreign exchange as a subject refers to the means and methods by which the rights to income and wealth in one currency are converted into similar fights in terms of another countries currency. Such exchanges may be in the form of one currency to another or on the conversion of credit instruments denominated in different currencies such as cheques, drafts, telegraphic transfers, bills of exchange, trade bills or promissory notes. Exchange is done through dealers in foreign exchange regulated by the central bank of the country. Banks are usually a dealer apart from other specialized agencies. One of the important components of the international financial system is the foreign exchange market. The various trade and commercial transaction between countries results in receipts and payment between them. These transactions are carried out t between the currencies of the concerned countries- any one of them or mutually agreed common currency. Either way transaction involves the conversion of currency to the other. The foreign exchange market facilitates such operations. The demand for goods and services from one country to another is the basis for demand for currencies in the market. Thus
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basically, demand for and supply of the foreign currencies arises from exporter and importers or the public having some transactions with foreign currencies. Companies having an import or export components in their business profile have to frequently deal in the forex operations. Forex operations in the country being supervised by the central bank, reference to the central bank in one form or the other is necessary use foreign exchange. If the country on the whole is a net exporter of goods and services. It would have surplus of foreign exchange, if on the other hand, it is a net importer then it would have the shortage of foreign exchange. The extent of regulation of the foreign market depends on the availability of foreign exchange in a country. If the forex is scares, then holding and using it would be subject to a lot of regulatory control. It also matters whether international trade forms a significant percentage of the GDP of a nation. If it is so, then the awareness about the forex regulation would be much more wide spread as compared to the situation where the foreign trade forms a significant portion of GDP. Presently, however, with increasing globalization, forex dealing has become a normal part of treasury operations. Every foreign exchange transaction involves a two way conversion- a purchase and sale. Conversion of domestic currency into foreign currency involves purchase of the later and sale of the former and vice versa. These transactions are routed through the banks. The takes the shape of either outright release of foreign currency for meeting the travel and related requirements or payment to outside parties in the denominated currency via the medium of correspondent banks. For effecting payment, following instruments are generally used:
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Telegraphic transfers (TT)
A TT is a transfer of money by telegram or cable or telex or fax from one center to another in a foreign currency. It is a method used by banks with their own codes and correspondent relations with banks and abroad for transmission of funds. As there is no loss if interest or capital risk in this mode, it enjoys the best rate for the value of receipts.
Mail transfers (MT)
It is an order to pay cash to a third party sent by a bank to its correspondent or branch abroad. It is issued in duplicate, one to the party buying it and the other to the correspondent bank. The amount is paid by the correspondent bank to the third party mentioned therein in the transferee country by its own cheque or by the by crediting in the party’s account. As the payment is made after the mail advice is received at the other end, which will take few days, the rate charged to the purchaser is cheaper to the extent of the interest gain to the seller bank.
Drafts and cheques:
Draft is a pay order issued by the banks on its own branch or correspondent bank abroad. It is payable on the sight but there is always a time lapse in the transit to in post between the payment by the purchaser of the drafts to his banks and the receipt of the money by the seller in the foreign center. As in the case of MT, there is risk of loss of draft in transit or delay in release of payment to the beneficiary and loss of interest in the intervening period.
Bills of exchange:
It is an unconditional order in writing addressed by one person to another, requiring the person to whom the order is addressed, to pay certain sum on demand or within a specified time period. If it is payable on demand, it is called a sight bill. If it is payable
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after a gap of some time, it is called a usance bill. Such bills can be banker’s bill or trader’s bill. Banker’s bill are drawn on banks abroad while trade bills are made between individual parties
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Unit 3: Treasury management vis-à-vis financial management. 3.1 3.2 3.3 model. 3.4 3.5 Organization models: dimensions. Tools of treasury management.
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Relationship between financial and Difference between financial and treasury Treasury organization: picking the right
treasury management. management.
Treasury Management
Unit 3 Treasury management vis-à-vis financial management. 3.1 Relationship between financial and treasury management
Finance function is a key element in the corporate activity. Its main objective is to keep a firm in a good financial health. To secure financial health, the finance manager has to perform the following functions: ? ? Investment functions and decisions Financing function and decisions
Investment functions estate to the efficient use of funds in alternate activities. The aim is to allocate funds to each activity so as to obtain optimal returns from such allocation. The short term and long term investment strategy has to be planned in line with the objective of maximization of wealth of shareholders. The utilization of funds as and when they accrue should take care of two prime considerations. The first consideration id that there should not be any idle funds and second consideration is that there should be no threat of liquidity crisis. Idle funds have there own cost and it results in lowering of there
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profitability. Extreme tightness of funds, on the other hand, raises the specter of default and loss of commercial reputation. So a delicate balance between these two conflicting objectives has to be maintained by the finance manager. It is in this context that the functions of finance become critical to the survival and growth of a firm. The financing function refers to the securing of the right resources of the funds at an appropriate cost and at the right times. Here the decision is to be taken about the least cost combination of funds for capital requirements and for working capital needs whether owner’s equity should be used for financing or should the firm resort to external financing? If the owner’s equity is to be arranged. What returns are to be assured? If borrowing has to be done, then what rate of interest is to be paid? In line with the twin objective of investment and financing, the finance manager has to take responsibility for all decisions pertaining to these areas. In the finance functions, a macro view of the requirements and uses of funds is to be taken. The finance manager has to arrange the funds within the approved capital structure of the firm. The funds may be debt or equity. Once the funds have been arranged it is left tot the treasury functions to utilize these funds according to the approved parameters. Finance management is also concerned with the overall solvency and profitability of the firm. By overall solvency we mean that the funds should be able at all times to meet its liabilities. The liabilities can be short term or long term. The long term liabilities pertain to payment of long term borrowings. Internal liabilities like payments to shareholders are matter of consideration once external solvency has been attained by the firm. Profitability means that the firm may at times face strain upon their profitability due to macro-economic or internal causes. But the firm should be in a position to earn reasonable return on its investments on capital employed. Capital operation of the firm means that both the owned funds and borrowed funds generate adequate surpluses for the firm. This can be ensured by investing the funds in such projects which provides optimal returns. The treasury function is concerned with management of funds at the micro level. It means that once the funds
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have been arranged and investments identified, handlings of the funds generated from the activities of the firm should be monitored with a view to carry out the operations smoothly. Since funds or cash in the lubricant of all business activity, availability of funds on day to day basis is to be ensured by the treasury manager. The role of treasury management is to manage funds in an efficient manager, so that the operations in the area of finance are facilitated in relation to the business profile of the firm. The treasury function is thus supplemental and complimented to the finance function. As supplemental functions, it reinforces the activities of the finance function by taking care of the finer points while the latter delineates the board contours. As a complimentary function, the treasury manger takes care even those areas which the finance function does not touch. Looked at marketing functions than the finance function. This is because the treasury department of a firm is involved in more frequent interaction with other departments. For the purpose of performing this role, the treasury manager operates in various financial markets including the inter corporate market, money market, g-sec market, forex market etc
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3.2 Difference between financial and treasury management.
Following differences can be observed between financial management and treasury management:
1. Control aspects:
The objective of financial management is to establish, coordinate and
administer as an integral part of the management, an adequate plan for control of operations, such a plan provide for capital investment
programs, profit budgets, sales forecasts, expenses budgets and cost standards. The objective of treasury management is to execute the plan of finance function. Execution of the plan takes care of the issue arising in routine operations of the firm which have a bearing upon the funds position. Thus the finance function of a firm would fix the limit for investment in short term instruments for a firm for example. It is the treasury function that would decide which particular instruments are to be invested in within the overall limit having regard to safety, liquidity and profitability. Again the finance function would arrange the borrowed funds for the firm but the treasury function would take care of day to day monitoring of the funds.
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2. Reporting aspects:
Financial management is concerned with the preparation of overall financial reports of the firm such as profit and loss account and the balance sheet. It also takes care of the taxation aspects and external audit. Based upon the performance of the firm, budget for the ensuring years are fixed. The reports are submitted to the top management of the firm. Treasury management is concerned with monitoring the income and expenses budget on the periodic basis vis-à-vis the budgets are fixed department/segment wise so as to dovetail with the overall corporate budgets. Variance from the budgets is analyzed by the treasury department on the continual basis for taking corrective measures. The corrective measures that can be taken are pointing out of the discrepancies to departmental heads and refuse payments that are not according to approved procedures and guidelines. The treasury department is also involved in the internal audit of the firm.
3. Strategic aspects:
The financial functions is involved in formulating overall financial strategy firm. The top management chooses the line of activity for the firm. The finance function firms up the investment and financing plans fir the activity. The strategic choices before the financial manager are the options for the investments and financing. While making the financial manager is taking a long term view of the states of affairs. It is just possible that the business of a firm may not be profitable in the initial years but it does not mean that the choice regarding investing has been strategically incorrect. In fact, there are many mega projects where the gestation period is even up to seven years. But given the correctness of the original assumptions, performance of the finance function would be measured by the number of years that gets reduced in breaking even. Strategy for treasury managements more short term in nature. The treasury manager has to decide about the tolls of accounting and development of systems for generation of
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controlling reports. The maintenance of proper system of accounting is one of the objectives of the treasury management. Another strategic objective for treasury management would be maintained of short term liquidity. This is done through regulation of payments and speedy realization of receivables.
4. Nature of assets:
The finance manager is concerned with creation of fixed assets for the firm. Fixed assets are those assets which yield benefit to the firm over a longer period of time. It can be said that the time span of a project coincides with the span of the fixed assets. In case the fixed assets have depreciated physically by significant measures, then a decision has to be taken for up gradation and replacement of the assets. The treasury manager is concerned with the net current assets of the firm. Net current assets are the difference between the current assets and current liabilities of the firm, both normally realizable within a period of one year. Current assets always are more than the current liabilities for ensuring liquidity of the firm. Current assets are the inventory, receivables and cash balances. Current liabilities are the trade creditors, statutory payables and loan repayable within one year. To ensure a healthy level of net current assets, the treasury manager is to ensure that the quality of the assets does not deteriorate. As regards investments, the finance manger is concerned with long term and strategic investments. These investments could be funded from borrowed funds or from internal accruals. The investments are expected to be held over a longer period of time as such day to day monitoring of the investments is not required. The treasury manager is concerned with short term investments. The tenor and quality of these investments has to be constantly monitored by the treasury manager for ensuring safety and profitability.
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3.3 Treasury organization: picking the right model.
Organizations have extended debates on the kinds of treasury they should have. The common themes include services that the treasury should offer the right size or structure and the right spread of management control. There are many dimensions to the structure of the treasury organization. Two key dimensions- range of services and extent of centralization of management control – define resultant organization models. The relationship between organization models and factors that influence decisions on the right models. The relationship between organization models and factors that influence decisions on the right model to adopt. There are various definitions of the word treasury. In its strictness sense, it refers to one function: asset liability management, especially when used in the context of banks. In a wider sense, treasury includes a whole range of activities encompassing various markets. A few significant activities are: Asset liability management: ? ? ? Maturity mismatch Interest rate type mismatch; Currency mismatch
Sales and trading: ? ? ? Currency, interest rate and credit products; Money market and long tenor instruments; and Derivative products
Risk management: ? ? Back office processing, settlement, and accounting; and Customer and regulatory reporting.
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3.4 Organization models: dimensions.
Any organization can exercise its choice on the scope of the treasury functions it undertakes. In doing this, it may be governed by a variety of considerations: ? It may choose to handle only those needs driven by utilitarian motives such as liquidity support or on the other hand, it may consider treasury as a “core” organizational process and hence handle the full range of services. ? It may choose to outsource portion of activities required or it may choose to foster these capabilities in house. Independently, an organization can also decide on the extent of centralization of the treasury management: ? ? It may be efficient to centralize back office processing, while the front office may need to be decentralized to aid speedy local decision making. It may be important to have a common risk management strategy, while execution may be decentralized. A study of common practices relating to the two key influencers – the range of activities supported and the degree of centralization or decentralization – at the treasury organizations globally suggests four models.
Full service global
Full service refers to the treasury that undertakes most, if not all, of the activities of the treasury management. Global treasury refers to one that either operated as the only treasury for all market across the globe, or ultimately combines all regional or local treasuries (that may exist due to legal or regulatory reasons) into a central treasury for pooling risk, for policies or strategies, for both these. In this sense, management of the
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treasury function in this model is very much centralized. Although this model readily lends itself to global organizations, it could also be used by local business that need to access global markets.
Full service local:
In this model, each treasury is a self contained local unit dictated purely by the needs of the local business. Thus, the treasury management functions are, by and large, decentralized. While this sort of treasury is usually the norm for a business with a local or regional spread. It may be adopted for global organization that operates as a collection of highly independent business units. Again, the range of services offered is full gamut, as described in the full service global model above.
Limited service global:
This model is different from the full services global model in that the range of services offered is limited. This could largely be due to the fact that certain activities are kept outside the purview of treasury and are handled directly by business units because the scale of these activities is not large enough to warrant the attention of the central treasury activities, with the exposure being managed directly by the concerned export or import or not managed at all. For those activities that are included in the treasury in such a model, pooling is a central level.
Limited service local:
This model is akin to having virtually little or no treasury activities, beyond local cash and liquidity management. These are very small decentralized treasuries where the concerned managers may also have other responsibilities in the finance department.
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3.5 Tools of treasury management.
Tools of treasury management:
Treasury manager is required to work in the fast changing and competitive environment. For carrying out his activities, he has to resort to certain tools and techniques. Most of the tools are originated from the finance
department and as such cannot be considered to be an exclusive prerogative of the treasury department. Yes it is the treasury manager who uses these tools most extensively. The tools are being described below:
1. Analytic and planning tools:
In the treasury functions, planning and budgeting are essential to achieve target and to keep effective control on costs. Analysis of data and information is necessary for planning and budgeting. Performance budgeting is referred to as setting of physical targets for each line of activity. The financial outlay or expenditure needed for each is earmarked to choose the least cost mode of activity. To achieve the targets. Productivity and efficiency improves by decentralization of responsibility and that is achieved by performance budgeting. Where each department or section is made a profit centre and is accountable for its targets, financial involvement and its profits in financial terms, relative to the targets in physical terms.
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This type of planning involving performance budgeting is best suited for service industry say a financial services company or bank where every department can function in a decentralized manner and achieve the targets.
2. Zero based budgeting:
Another tool of analysis and performance is zero based budgeting wherein each manager establishes objectives for his functions and gains agreement on them with top management. Then alternative ways for achieving these objectives are defined and the most partial way for achieving the target is selected. This objective for each incremental level of activity, costs and benefits are assessed. The alternative with the least cost is then selected.
3. Financial statement analysis:
Financial analysis of the company is necessary to help the treasury manager to decide whether to invest in the company. Such analysis also helps the company in internal controls. The soundness and the intrinsic worth of the company are known only by such analysis. The market price of the share depends, among the other things on the sound fundamentals of the company, the financial and the operational efficiency and the profitability of that company. These factors can be known by the study of the financial statements of the company.
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Unit 4: Regulation and environment of treasury management. 4.1 4.2 4.3 4.4 Internal treasury control. Treasury control mechanism. Environment for treasury control. Supervision of treasury operations
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Unit 4 Regulation management. 4.1 Internal treasury control.
All the economic units have the goal of profit maximization or wealth maximization. This objective is achieved by shot term and long term planning of funds. These plans are incorporated in the budgets in the form of activities and corresponding targets are fixed accordingly. The next step in the process is the control function to see that the budget is being implemented as per plans. Control is thus part of planning and budgeting in an organization. Control is the process of monitoring to ensure that the activities are being carried out as per plans. It is also noticed whether there is any divergence from the plans, what are the reasons for divergence and what are the remedial actions can be suggested.
and
environment
of
treasury
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Internal treasury control is a process of self improvement. It is concerned with the flow of funds, cash and credit and all financial aspects of operations. Fro time to time and on regular basis, the internal treasury control is exercised on financial targets. The financial aspects of operation include procuring of inputs, paying creditors, making arrangements of finance against inventories and receivables. The gaps between inflows and outflows are met by planned resource to low cost mix of financing. The control aims at operational efficiency and removal of wastage and efficiencies and promoting of cost effectiveness in the firm. The control is exercised under phases of planning and budgeting. These phases include setting up of targets, laying down financial standards, evaluation of performance as per these norms and reporting in a standard format. The quarterly and annual budgets would set the targets for each department and financial standards are set out for each activity. Monthly budgets are evaluated by the performance sheets maintained daily and regular reports go to the financial controller. Reporting and evaluation go together and on the basis of information system built in the past, plans are prepared for the next period.
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4.2 Treasury control mechanism.
Treasury management relates to the most of the highly volatile instrument’s market dealing. The volumes of transactions involved in the dealings are usually heavy and risks in operations are also heavy. So any unorganisation operation will create heavy loss for the institution. Generally control system may be related to a. Internal control of different, dealing rooms, settlement office and control offices. b. Checking of unhealthy insider trading systems. c. Mutual and amicable solutions of different conflicts of interest in dealing operations.
Internal control system: It relates to forming policies to check leakage of profit to the institution. In treasury operation, the role of central office is vital. They should form suitable guidelines for the institutions in respect of various treasury dealing operations. There are advices dealing operations to diffract all treasury items in different classes according to risk involvement. As a treasury business is a risky business responsible positioned persons should be delegated powers to deal in treasury operations with imposition of different limits on their discretionary powers.
Some important areas should be taken:
i. ii. Fixation of rates on each treasury items Fixing limits on dealers to deal with different counter parties, with proper observation of confidentiality and adherence to best market practice.
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Treasury executive should be ensured that the transactions id carried in a correct manner by cross checking during each dealing day. For above facts the central offices should develop proper policies and guidelines for treasury operations and should advice the dealers to deal according to policies of the following:
i. ii.
Restriction on dealing in one’s own account. Timely advice to deal offices in respect of any adverse transactions received or excess reporting.
iii. iv. v.
Timely submission of returns to different statutory authorities. Review of securities and contingencies arrangement of different offices. Proper verification of compliance given by lower offices for irregularities.
Insider dealings:
Insiders are those who are in management including near and dear, and their dealings means taking advantages of published internal information of the corporate body. These may create price sensex situation. So these unadvantage dealings should properly efficient internal control system should be taken by the management to eliminate insider dealing by fixing penalties for insider dealers.
Treasury operations in banking:
All banks/financial institutions (core principals and brokers) should ensure that they should try to serve for giving best services in the market operations with code of conducts issued for time to time. Core principals should be conducted noninvestment business with private individuals should segregate them into retail or wholesale for smooth function of business within sound guidelines. It is essential that all staff should be familiar to code of
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conducts. In professional manner while entering into dealing transactions.
Banks/financial institution will be responsible for dealing actions of the staff members. It should be segregate work for the staff members such as no staff member should control the full operation. Banks/financial institution should identify any potential or actual conflicts of the interest that might arise while undertaking wholesale market transaction; and take measures either to eliminate these measures and to provide fair treatment to counter parties. Banks/financial institutions should know their counter parties and their credit worthiness before entering into contract. It is good practice for principals, subject to their own legal advice, to alert counter party to any legal or tax uncertainty which they know are relevant to be proposed relationships or their transactions. All relationships have their responsibilities to assessing the credit worthiness of their counter parties whether dealing directly or through broker/firms. Banks/financial institutions should take measure of risk control and to meet legal financial obligation for each contract to minimize the loss. It is better to prepare a dealing mandates for each transaction. The mandate will be helpful to clarify the extent of the relationship between core principals and their customers with responsibility. Banks/financial institutions should observe confidentiality. It is essential for the privation of the reputable and efficient market place for banks/financial institution. The transaction should not be dealt in non market rates. So this practice should be avoided. Adequate safeguards should be established to prevent abuse of information by staff members with respect to non public price sensitive information.
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4.3 Environment for treasury control.
Environment for treasury management:
Treasury management is carried out in the real corporate world and the corporate functioning is carried out in the overall corporate environment. Environment of treasury operation can broadly be classified as under:
a. Legal environment b. Regulatory environment c. Financial environment a. Legal environment:
By legal environment we refer to the legislation where govern corporate functioning. These legislations are the one pertaining the company law, taxation industrial regulation etc.
b. Regulatory environment:
The regulatory environment encompasses regulation regarding employment, wages, and laws, promotion of units and closure of units etc.
c. Financial environment:
The financial environment pertains to policies regarding monetary and fiscal control, financial supervision, exchange control etc
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4.4 Supervision of treasury operations.
The treasury operation department is responsible for treasury’s middle and back office functions, all systems services, and particularly cash management and banking relation services. Treasury operation’s cross-functional staffs provide pricing and valuation, performance measurement, transaction and securities processing and compliance support functions. The middle staff provides quantitative analytic support and operational risk reporting and coordinates treasury’s control risk assessment related to internal related to internal corporate governance and risk management functions. Treasury operations implement and manage information system in support of treasury’s asset management, funding, pension investment, and cash operations functions. The role of treasury manager is to manage mitigate and monitor financial risk arising due to difference in currency basis and timing of pledges from donors, disbursements and debt services. The risk management rules that are used include among the others currency swaps and currency forwards interest rate swaps and currency forwards rate agreements. Treasury management comes under master derivatives agreement and hedges risk positions using its counterparties in the market.
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Risk management generally incorporates:
? ? ? A prudent approach to balance sheet management, with the aim of mitigating and controlling financial risks; Suitable risk limits and policies and procedures formulated to ensures that the limits are not breached; and Appropriate systems, controls and reporting mechanism for measuring and monitoring residual risks. In this context, the role of treasury manager typically includes:
a. Policy analysis:
Develop the risk management framework, taking into account board’s risk preferences, balance sheet dynamics and market limitations, as well as credit, interest rate operational; and foreign currency risks, and the different instruments available for risk transfer.
b. Strategy design:
Advice on the optimal risk transfer through a broad based still risk to be hedged out and the instruments available, based on the modeling and evaluation of risk management options.
c. Structuring; negotiating and executing transactions:
The treasury manager is responsible to efficiently remove interest rate and foreign currency exposure based on board approved risk management strategy; typical decision making on the risk management strategies; tactical decision making on overall execution strategy and timing for transaction on the different currencies to accommodate to market and liquidity limitations; benchmark counterpart market quotes based on in-house models negotiate prices and ensures best execution.
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Present status of treasury management in India:
Treasury management is still in infancy in India. It is still considered as a sub function of the financial management. In most of the companies, it is the finance manager which is also taking care of treasury functions. Treasury operations are carried out professionally and systematically by some banks and financial institutions. The first stage of evolution in treasury management is the establishment of a treasury function. The second stage is running it as a profit center. In India, treasury operations at the micro level are expected to grow at a fast pace with increasing integration of the Indian economy with the world economy.
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Conclusion
Treasury management is the science of managing treasury operations of a firm. Treasury in its literal sense refers to treasure or the valuables of the government. ? Macro level: It is the inflows and outflows of cash, credit and other financial instruments are the functions of the government and the business sectors. These inflows are arranged by them as borrowing from public. In this sectors the ratio of savings to investment is less than one, i.e. the savings are inadequate to fund the investments ? Micro level: the finance manger aims at optimizing the value of his assets or wealth and minimizing the burden of his liabilities. He may seek to maximize his operational profits and seek to maximize the wealth of stakeholders of the micro level. ? The availability of funds in right quantity, Availability in right time, Deployment in right quantity, Deployment in right time and profiting from availability and deployment are the main objectives of the Treasury Management. ? ? At unit level, treasury manager’s activities encompass all other management functions. Treasury manager monitors the cash flows of the unit on a continual basis. It is ensured by him that adequate funds are made available for day to day working of the unit. In case there is genuine shortfall in cash flows, the outflows are made in an order of priority with the more urgent payments being m ? ? At domestic level or national level treasury management function is o channelizing the savings of the community into profitable investments avenues. At the international level, the function of treasury management is concerned with management of funds in the foreign currencies.
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? ? ? Analytic and planning tools, Zero based Budgeting and Financial Statement Analysis are the various Tools of treasury management. Internal treasury control is a process of self improvement which is concerned with all flows of funds, and credit and all financial aspects of operations. Environment for treasury management can be broadly classified as Legal environment, Regulatory environment and financial environment.
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