Essay: Role of Treasury Is Central to the Success of Any Organization

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Role of Treasury

The role of the treasury is central to the success of any organization. The support functions of the treasury not only are essential for basic function of the organization, but can also provide the organization with a source of competitive advantage. Some of the functions that the treasury performs within the organization are addressing financial risk, raising capital, setting the firm's capital structure, tax minimization, preparation of financial statements (especially the balance sheet), and dealing with issues related to financing (Duong, n.d.).

The treasury management can be broken down into two main components -- basic cash management and advanced cash management. The former refers to short-term events, such as collections and payments, liquidity management and short-term treasury forecasts. The latter refers to financing treasury deficits and managing financial risks (San Jose, Iturralde & Maseda, 2008). The short-term events are a basic support function, without which the organization could find itself subject to financial complications. For example, if obligations are not met, the organization's borrowing costs could increase. This stands for both bank obligations such as revolving credit or loans, and for trade obligations where the vendor may tighten the terms of payment. In order to allow the firm to meet its obligations, the treasury must manage its liquidity. In most organizations, it is uncommon to hold a substantial amount of cash on the balance sheet. Cash does not earn much interest, which means it loses value over time. Thus, the treasury's liquidity management role is to keep the firm's cash supply invested to earn enough interest that the real returns are positive, but to have sufficient liquidity in these investments that the firm is able to meet all of its obligations (Pan, 2006).

In order to meet these obligations, the treasury needs to develop accurate forecasts of the treasury's needs. Each obligation needs to be recorded and scheduled, such that each day's cash outlay is tabulated. The organization's cash inflows must also be recorded, so that the treasury knows each day how much cash is needed, and therefore what investments need to be liquidated, if any. Short-term cash management is one of the base functions of the treasury, and provides for the smooth operation of the firm.

The treasury also plays a valuable role in determining capital structure. The firm's capital structure refers to how the company finances its operations, through a combination of debt and equity (Loth, 2010). The capital structure impacts on the risk level that the company faces. A firm with a high degree of debt has a high risk level, while a firm with a low degree of debt has a low risk level. The appropriate risk level for the firm is determined in part by the firm's operations, industry and stage in its life cycle. The capital structure impacts on the cost of capital for the firm (weighted average cost of capital), which can impact not only the price it pays to raise money but also impacts on the types of projects that the firm can undertake (marginal cost of capital). Managing the capital structure is one of the most important roles of the treasury because it can have significant impacts on management's ability to pursue strategy -- the marginal cost of capital the firm faces will determine the choices management is able to make (Oglivie, 1999).

The treasury is also responsible for financing projects. Because the treasury ultimately manages the capital structure of the firm, it is also the role of the treasury to advise on financing decisions for the firm's projects. First the treasury must evaluate the ideal method of financing -- cash (retained earnings), debt, share issue, etc. -- and then must iron out the details. The treasury structures deals, in particular with regards to new financing, in a manner that lowers the cost of capital or provides the firm with the strongest strategic advantages. The treasury also applies this function to merger and acquisition activity as well, and to entering new foreign markets. The treasury's expertise in structuring deals is critical to increasing the returns on the deals that management makes, which can mean millions of dollars of additional shareholder wealth.

The treasury also plays a critical role in risk management. The treasury is responsible for managing a number of different risks, including liquidity, interest rate, exchange rate, commodity price, credit, capital, investment and sovereign risk (Duong, n.d.). Liquidity risk is that which relates to the company's liquidity. Interest rate risk is faced by the firm on all of its floating rate debt and credit instruments. When the prevailing interest rates of the country fluctuated, the value of any floating rate instruments will change as well. It is the role of the treasury to manage this risk so that the organization is not unduly exposed to interest rate fluctuations. The treasury must effectively lock in favorable rates and manage the duration gap of its holdings (Belongia & Santoni, 1984).

Exchange rate risk is a fact of life for organizations operating internationally. Exchange rate risk can have a profound impact on the profitability of foreign operations. While there is nothing that the treasury can do about translation risk, the treasury can manage transaction risk. The organization finds itself exposed to exchange rate risk when it buys or sells in another currency. The treasury can manage this risk by selecting a hedging strategy, which can lock it the currency exchange at a profitable level. There is a cost to exchange rate hedging, so the treasury must weigh the costs and benefits of each tactic.

Commodity risk can also be addressed by the treasury. This is especially important for firms that are dependent on commodity inputs, such as jet fuel for airlines, metals for factories and agricultural products for food makers. The treasury cannot control the prices on the world commodity markets, but it can advise on and execute hedging strategies that will allow the firm to develop cost certainty with regards to these key inputs. Commodities markets are highly volatile, which emphasizes the need for strong treasury control over this significant risk (PriceWaterhouseCoopers, 2009)

Risk management of all types is conducted by forecasting exposure. The treasury department must undertake economic analysis in order to understand what factors in the macroenvironment and competitive environment can impact on the firm. The tactics and strategies of the treasury are essentially responses to its interpretation of risk, which implies that the forecasting function is perhaps the most important treasury function and the measure of a treasury's success is ultimately going to be reflected by its ability to forecast and address potential financial exposure of all types.

Risk management is a critical treasury function for most firms. If the treasury does not perform the risk management function effectively, the firm may be subject to price shocks on its key inputs or on foreign exchange transactions and it may be subject to an increase in its cost of capital if liquidity risk is not properly managed. The treasury can also turn risk management into a source of competitive advantage. Should the treasury be able to consistently reduce the downside risk of the firm in these key areas listed above, it will contribute to a lower cost structure overall, which can allow the firm to either generate greater profits than its rivals or could facilitate the firm undercutting its rivals on price. In either case, the treasury is a key support function precisely because of the high degree of impact that it can have on the firm's cost structure and financial efficiency.

The treasury also contributes to the organization with its role in information management. The treasury produces reports and advice that managers can use to help them make better decisions. The usefulness of this role is limited by the ability of the treasury to disseminate this… [END OF PREVIEW]

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